Over the past decade, the world’s central banks have distorted the price of money by bringing interest rates to record lows.
With credit so cheap, asset prices have risen dramatically as companies and governments have borrowed to the hilt.
And now with the “Everything Bubble” threatening to burst (perhaps in mid-bursting already?), we’re suddenly realizing that the phantom asset price gains were ephemeral, while the debts are permanent.
How will the economy cope with dangerously overleveraged nations, industries and households? Not well.
To discuss this massive problem and propose some potential solutions is Steve Keen, professor of economics at Kingston University in London and author of Debunking Economics:
The basic idea behind a modern debt jubilee is we’ve let far too much private debt accumulate by allowing the financial sector to exercise the rights of being able to create money without exercising the responsibilities that should come with it.
What they’ve done is do the brain-dead thing of funding asset bubbles because it’s easy to just give somebody money to buy a house. That causes the price of the houses to go up. And then you get nice large bonuses on that. And when the bubble bursts, who cares? You’ve already moved onto another company or you’ve taken out so much it doesn’t matter to you.
It’s been incredibly irresponsible lending not for producing physical infrastructure but for speculation on the price of assets which your own lending is causing. And then of course we’ve had all these people who used to be decent engineers and physicists becoming financial engineers, which is absolutely disastrous for our capacity to build our way out of the ecological crisis we’re facing.
Steve Keen: Actually, it goes way, way back because my interest in economics when I was an undergraduate student, when I was a school student and they asked me what I wanted to do in a vocational course. I said I wanted to do economics and engineering. There is no such combination so I was pushed into economics major instead. But I did engineering mathematics in my first year. So, I’ve always had a background in engineering and physical sciences and physics. It was only six years of lousy science teachers at a Catholic boys’ school that ended up turning me into an economist rather than a physicist. So, that’s not uncommon. I think it’s quite a lot of economists actually end up that way. But I was heavily influenced by the Limits to Growth which I saw as a bit novelist study of the actual interacting feedback systems that determine our physical economy and our ecology. And horrified to see economists like Northouse, specifically Nordhouse demolishing the credibility that incredible study. And I’m denigrating people like Jay Forester in the process. So, I’ve always wanted to bring energy in and I’ve always been dissatisfied not just with how economists ignore energy completely, so mainstream economics and post Keynesian for that matter. Both model protectionist involving labor and capital with no energy. But even people who try to bring energy intended to add it as a third factor of production.
And that never jived with me because if you are using a neoclassical what’s called Cobb-Douglas production function you have labor, capital and energy as three independent inputs. You can set up the parameters so that energy has zero role or if you set it up according to what’s called the cost share theorem which the–the coefficient was raised to a power these different independent inputs to give you constant returns. If you double inputs, you double outputs. So, a sensible constraint on a mathematical model of production.
If you set according to the share of energy in the GDP, you get a sick coefficient for energy at about .07. Now, that means if you do the mathematics of a Cobb-Douglas production function–if you cut energy by 90% GDP would fall about 10 and that just was complete nonsense to me. So, I was always trying to bring it about to say I wonder what this brings this in a fundamental way and the simple insight I got, which is within 10 minutes I turned it into an explanation, both what made the complex function appear to work and what was the weakness as well--labor without energy, is a corpse. Machinery without energy, capital without energy is a sculpture. Both need energy to turn, to create. And so, what you have is rather than energy is independent input to the on an equal footing with labor and capital. Energy is an input to both labor and capital, without which they can’t function. And then you get a much more realistic picture where energy plays a critical role in the production of anything. And of course, we are having energy you never convert according to the second law of thermodynamics you can never convert all the energy into work, unless you live in a part of the universe which is at absolute zero. There is no such place. Therefore it all has waste being generated. So, once you have energy as an essential input into production you also say should I waste energy which fundamentally takes the form of waste matter in our production system. Of course, essentially–importantly but not essentially–only being C02.
You have a direct link between economics and ecology. So, that was something I did about three years ago, and I’m now following that argument to rewrite economics from the ground up so it starts with energy as the fundamental input and fundamentally sees GDP as useful work.
Click the play button below to listen to Chris’ interview with Steve Keen (59m:55s).
Chris Martenson: Welcome everyone to this Featured Voices podcast being hosted at PeakProsperity.com. I'm your host, Christ Martenson. And it is July 23rd, 2019. As of today, the world's central banks are thoroughly out of fresh ideas and that's if they had any to begin with. There's always--you know there always has to be some sort of relationship, right, between the economy--maybe as measured by the GDP and the claims on the economic output. And this is something a lot of people forget about--stocks, bonds, currency--those are all claims on the economic output. In particular, future economic output. Now, central banks--they're very good at creating asset price inflation which they have done massively in the past 10 years. Stocks at record highs are close to them, bonds are record low yields which means record high prices. So mind-bogglingly off the reservation that there are, even as of today, European junk rated companies whose bonds are trading with negative yields. Now if you can't make any sense of that sentence, don't worry--that means you're normal. But the central bankers this is all somehow explicable and can be rationalized away. But can it?
And what if the recent calls in the U.S. political debates for modern monetary theory or MMT injections a freshly printed currency handed out to the people this time instead of to the banks? After 10 years of printing and mispricing money and fostering a massive surge in the levels of debt all the central bankers have got to show for their efforts are--low to nonexistent to even negative rates of economic growth and an enormous largest ever wealth and income gap. Hardly the sort of inspirational outcome they were hoping for--presumably.
So, they keep going more of the same in hopes it will all turn around soon enough. But what if their basic models are wrong. What if the core tenets of the economists currently running the monetary show are simply wrong? Even worse in my mind is that the entire model of growth is now a significant danger to our futures and there are no mainstream economists even questioning that despite all the ecological disruption that we see and that of course goes hand in hand with too fast rates of resource extraction.
Infinite growth was never a possibility on a finite planet. We are now bumping into that reality but it's not part of the larger dialogue. Well, if the central bankers have the models all wrong and are pursuing destructive growth then a very large financial catastrophe is not only a possible outcome but a likely if not, assured outcome. Which means, there's literally nothing quite as important to your financial, if not physical future as understanding economics and what the central bankers are intending to do and why.
Today's guest is the perfect individual to help us sort out what's going on and what the true risks are in this story. Professor Steve Keen is an Australian economist and author. He's a post-Keynesian who includes debt in his models. I know, what a rebel. And criticizes neoclassical economics as inconsistent, unscientific and empirically unsupported. And of course he's being very kind in phrasing it that way. He's the author of the book, Debunking Economics and hosts the popular blog debtdeflation.com. I'm really excited to have him bank on the program. I got 100 questions. Welcome, Professor Steve Keen.
Steve Keen: Thank you very much. I would actually just clarify one thing. I am now actually the--the debt deflation is sort of active, but the main way that I post these days is on my crowdfunding site on Patreon, which is at patreon.com/ProfSteveKeen.
Chris Martenson: Yes. I've noticed that and I want to get that on the backend because I think what you're doing is super important around that. But let's dive right in. Hey, Steve, what have the mainstream economists got wrong?
Steve Keen: Do you want to rephrase the question--what have they got right?
Chris Martenson: Yes. What have they got right?
Steve Keen: Yeah. Okay, now I'm struggling.
Chris Martenson:Everything and nothing is a perfect set of answers.
Steve Keen: What they've got right is a way of thinking about reality that makes everything look like it's honky dory. And in that sense there is an ideological defense for the current--for the status quo when it is a completely inaccurate description of that status quo. And that's what most disturbs me. I think you can make enormous arguments for capitalism in the sense of an engine of innovation, of growth and dynamism and change. And that is entirely what they haven't done. They instead said it is a perfect vehicle for shaving equilibrium and satisfaction of everybody's utility and--and the lack of any--any social conflict. And they also for the best and pray for an optimal world. You couldn't get a less accurate description of capitalism. But a bit like the old Ptolemaic theory of astronomy it fits--they tweak the parameters until such stages it appears to fit the past data. But they haven't got a hope in how they're working out the future. And in that sense, they are actually jeopardizing our future, which is my main focus today.
Chris Martenson: Well, I really want to get to that. I do think they are jeopardizing the future but let me back up. So, I said you had criticized neoclassical economics as--as inconsistent, unscientific, empirically unsupported. Look, you know, one of the things that they are saying right now is that they are driving rates down because they want to spur growth. But I can crank up any old you know, 15 year long chart of GDP and discover a downward trend. Isn't that enough data to say maybe that whatever they're doing needs a tweak?
Steve Keen: Oh, the data is just overwhelming against their arguments completely, Chris. This is--data, they massage data through what's called econometrics and there's an excellent old paper by a guy called Ed Leamar called Taking the Con out of Econometrics. And if you read it is quite possible to fit these models which are fundamentally the economists--econometricians in general mainly linearly squares type modeling. And if you have enough variables and enough tweaking of the parameters and assume everything is normally distributed in the error term you can fit the data into the trends so you don't have any data model changes. So they really are free of data.
And I'll give my favorite example of that--everybody is saying the classic old textbook of downward sloping demand curve the higher the price, the less the demand. The lower the price the more the demand and a rising supply curve. Now, the rising supply curve you know, which makes in some ways you want more of something you gotta pay more for it that is the gut appeal it has for most people. When you take a look at how they logically derive that, they assume that there is a level of fixed capital stock which they call a fixed resource and a variable input - mainly labor, and they say you have an increasing amount of labor rather than for capital, then you might initially get an increase in per work or productivity then you get a falling level of productivity and they call this diminishing marginal productivity.
Now, when you go and research actual firms and ask what is the slope of your supply curve was with this theory of diminishing marginal productivity they get a rising supply curve. That's the entire foundation of that rise in curve in the literature. They say that the short run costs--not their long run--their short run costs fall with output. The more output the lower the cost per unit. Both in terms of falling fixed costs and often a rising efficiency of the--of their use of variable capacity. And economists completely ignore this. In fact, the key paper if you most people know from Milton Friedman about methodology called The Methodology of Positive Economics is literally written to say don't bother reading the empirical papers in the American Economic Review about the actual cost structures of firms. So there's--there's a foundational belief the rising supply curve, you do your empirical research and found for most firms it's a falling supply curve. Does it show up in the textbooks? No. And it's even after one of the most recent people to find this empirical irregularity compared to the theory was Alan Blinder, who was actually the Vice President of the Federal Reserve and vice president of the American Economic Association.
Even when some like him finds it the results just get varied. So, they couldn't give a damn about empirical data and unfortunate empirical data couldn't give a damn about them, either.
Chris Martenson: Well, let me give you one of my favorite examples and that is a great one. Recently, I’ve seen both the ECB and the U.S. Federal Reserve come out and claim openly that their policies are not at all responsible for whatever wealth gaps exist at this point in time. And I struggle with that greatly, Steve because it's completely obvious to me what the transmission mechanism is if you throw money into financial markets and those markets go up and the primary holders of those assets happen to be rich people--they get richer. How could that even remotely be up for debate?
Steve Keen: Yeah, I know. In fact, it is rather disingenuous because if you read Bernanke's statements on the idea of stimulating the stock market, stimulating asset markets it was because he called it the wealth effect. He thought that people get wealthier they are more likely to spend more and stimulate the economy. Now, you don't get a wealth effect unless you make people wealthier. So, the purpose of QE was to increase asset prices. A simple way that I describe it, leaving out the leverage that applies when you buy shares as well, QE was a trillion dollars a year in the United States roughly. The Federal Reserve declared they were on the buy side of market operations to the tune of a $80 million per month, which is pretty much a trillion dollars per year.
That means every year, simply by an accounting operation the federal reserve is putting a trillion dollars into the bank accounts of financial institutions in return for a trillion dollars' worth of bonds out of the books of the Federal Reserve. Now if you look upon the financial companies can do--by law a financial company must buy financial assets, they have to cover the costs of operation as well. But primarily, they buy financial assets. If they can't buy bonds, what are they going to buy? Shares and some property. What's that going to do to the process of those? A trillion dollars per year--drive the prices up. Even if it's a simple transfer, so rather than leverage coming into the operation you have increased the value of these shares by a trillion dollars.
Then, when people who own those shares are a trillion dollars richer, they may then sell some of those shares themselves to capitalize the gains and then spend some of that money into the real economy. So, maybe the trillion dollars if you include all the bankers' fees and the wages they pay themselves from which they buy the old Lamborghini--that could be really $100 billion of stimulus into the real economy. But as my great friend Michael Hudson puts it -- a wonderful turner of phrases he said the Federal Reserve helicopter falls and lands on Wall Street, not Main Street. So some is linked across but it has dramatically increased inequality. And I think it's just ludicrous for anybody to claim otherwise. Especially, the architects of this who did it because of what they call the “wealth effect.”
Chris Martenson: We are going to increase the wealth effect but trust us it's not going to actually drive a wealth gap. Yeah--there is some hocus pocus in between those two statements, of course. And it is disingenuous and self-serving. But the thing that, I guess, drives me nuts is not only A. do they feel comfortable saying it but B, I don't see them challenged by the financial press. You know, nobody ever asks the follow up question or the financial services in--in congress. Nobody asks a follow up question. How can you even say that? Right?
Steve Keen: Yeah, I know. They just get away with it. This where when you see how Greenspan in particular managed to make obscurity into a--a marketing vehicle by making comments that you know, completely bamboozle everybody listening, including himself. But the aura of mystique about them and there are plenty of studies to show the extent to which the federal reserve dominates academic funding. And of course, also for journalists. I pine for the days when you had investigative journalists being primarily hired by newspapers these days because the newspapers completely blew the model of the internet. They are all basically on life support. And the easiest thing they can do is they have these press releases. If you come up with some critical--if you criticize the press releases, you might not get the next press release or the next solicitation with the person releasing it. And that might have given us a very obsequious media when it comes to examining the actions of the officials like the Federal Reserve chiefs.
Chris Martenson: This is ancient history, of course, because it goes all the way back to Janet Yellen so we might as well be discussing Mongolian times under Genghis Khan. Remember Janet Yellen was actually asked a follow up question by a journalist once about some very devious insider stuff that happened at the Federal Reserve, where they were inappropriately communicating with a financial firm. And that person was kicked out and never invited back to another Federal Reserve press conference. It was a public hanging as we call it in the business world. Where all the other journalists took note of that and said oh I don't want that to be me. And they got away with it, too. I was quite surprised.
Steve Keen: Trump does a similar thing in the White House, which we all see and object to. But of course, the Federal Reserve is doing exactly the same bloody thing.
Chris Martenson: All right, Steve, I need you to get out your neoclassical decoder ring because a lot of my listeners are very confused by when the Fed says the inflation is too low. They say it, they say it and then the press doesn't even follow up with that. It simply repeats it. But I can imagine the common person needs a little bit of explanation for that policy. So why should explain to us now why should the common person want rising instead of falling prices for things? You know, what does the Fed really mean here? Because they can't really mean that people want rising prices. None of us do. But they do. Why is that?
Steve Keen: That is actually two--you got two questions conflated there. So, I'll just pull back and say one. Why would the ordinary person want rising prices? Irving Fisher answered that very well during the Great Depression. Because he said what caused the Great Depression was a disequilibrium event. He was very specific that it was not equilibrium. He couldn't realize his mistake to see it coming was by thinking the financial markets are an equilibrium factor of the economy. He said, what the disequilibrium events cause the crisis of too much lift at its beginning and too low rate of inflation at the same time. And he then said what can happen with that is when people try to liquidate, particularly businesses, when they try to liquidate their stocks to reduce their debt, the liquidation drives down prices. They then pay the debt off that they have in nominal terms but the decline in GDP can actually be bigger than the amount of debt that they pay down, and what you therefore see is the phenomenon of a falling level of debt in absolute terms but a rising level of debt to GDP. And when I don't know that Fisher had access to the same data that I've got now on what actually on that happened in 1933. But if you take a look at the data what you normally see there is a huge increase after 36 in the ratio of private debt to GDP in America. And that sort of what everybody focuses upon. When you look at the actual data, you see that across that period of time debt was falling in nominal terms at the rate of something like 5 or 10% per annum. But the GDP was falling by 20 to 25%, 10 to 15 from the real decline in output and 10% from the fall in CPI. So that you do not want to be in that circumstance. And if you don't actually have bankruptcy laws and you don't have things like the New Deal and stuff coming in. The end product that was always in economy was zero GDP. It is just overruns everything and nobody produces anything.
So, that's the reason an ordinary person even has an interest in it because if there is debt, if we have private debt in the economy and we do--then we don't want to have the rate of inflation so low that that danger is a possibility and that is why I am generally saying that a bit of inflation is a good thing because the inflation itself is the increase in nominal values is reducing the debt burden of the also nominal debt you have at the same time. So that is what I see as the realistic case for it. I’ll give you, yeah.
Chris Martenson: Please, if you want to continue the thought--please do.
Steve Keen: Yeah. Well, what did the Fed do about it. The Fed is a typical outpost of neoclassical mainstream economics. They do what they call dynamics to cast to equilibrium models these days. And the models are extremely complicated. They are not complex. They are complicated. The atomic astronomy analogy comes to mind. The atomic model of the solar system is incredibly complicated but not complex.
And in that model that had three magic numbers. There is a 2% rate of inflation, a 3% rate of economic growth and a 4% rate of interest. And those--those numbers are almost hardwired into all these models. And that is why think we should be above 2% so we can actually impose high interest rates to bring it down. But of course, what they are finding themselves now is below the 2% rate and have no idea how to pump it up and very effectively unintentional, of course, in the last 10 years.
Chris Martenson: So, looking back at that data you talked about yes, I see that big bump in debt to GDP starting at 29 to 35 or so, right? And as you mentioned that bump isn't because we are taking on lots more debt. It's because GDP was falling faster than debt at that moment in time. But since the 1970's we've had this whole financialization kick. And we do have rising debt to GDP. And that's because debt is now compounding at a faster rate than even nominal GDP. And that is what I think has been enshrined at the central banks is how things are supposed to work. But isn't there a math problem sort of baked into that? You can't grow the claims faster than the economy forever, can you?
Steve Keen: No. If you look at the data you got to break it down into all different types of debt, as well, Chris, we can defer that to later. But if you look at the level of private debt that in America's case rose from about--I'll bring up the numbers as we speak. Should have brought this up earlier one of my documents to see the number back in the Great Depression period. But if debt, private debt in America began right after the Second World War went to 30 to 40% of GDP. It rose to 170% shortly the peaking shortly after the financial crisis. And then it has fallen to 150% of GDP and it's now flatlining about that level. It is actually as a percentage of GDP falling a bit right now. So, what you had is the whole period up to 2007 was an increasingly credit fueled bubble where change in debt, which is what creates credit, was positive and therefore that gave you additional demand and that argument by the way sets me outside the mainstream completely. But the additional demand came at the expense of accumulating more debt. You can keep on doing it over such time that people are no longer willing to take the debt on. They felt to belaboured to begin with. Too many debt financed projects fell over. The Ponzi schemes suffered the subprime market coming home to roost. All that happened and that's the end of the bubble. What you're left with is an enormous level of private debt that, it can sequel on literally for decades.
And in the case of Japan, Japan went through exactly the same process 20 years before America with its bubble economy bursting in 1990--when it burst, its peak level of debt 225% of GDP--that's private debt. It's now at 170%. Of course, we all know that Japan has had extremely sluggish growth to negative growth through all that time period. And what I said when I saw a financial crisis coming is we are all going to turn Japanese. And that's the state of the American economy is in right now.
Chris Martenson: Well, Japan though. I mean if we said listen, the economy there is to serve the people not the other way around and in this case I think when we're talking central banks we talked about the economy but they're really talking about the banking system. I think the economy is a derivative of that. They care that they have a stable banking system. So, I can make a strong case for why Japan ought to have a falling GDP, right? They got they are losing population. And the population that remains is aging rapidly, as on a demographic basis. So, to me that says hey, Japan should have a falling economy but the system of banking can't stand that. Isn't there a conflict there when you have a -- an infinite growth, perpetual growth based banking system and we can discuss whether or not that has to be true. But it seems to be true, right?
Steve Keen: I agree with that. And the, but the thing is Japan's growth didn't stop when it had the demographic crisis. Japan's growth stopped on a dime on the 31st of December 1989 when the bubble economy burst, at which point the Nika was almost 40,000 points and it finally fell to about 7. It wasn't the demographics that took the wind out of the economy. It was the collapse in the financial sector. But the demographic system because it is a declining level of the population has actually softened the blow. And that--that is something that is actually advantageous with a falling population.
Chris Martenson: Well, you know a lot of your work is really informed by thinking over time and one of the seminal pieces was just that simple spreadsheet with the math you showed that said listen, if a government is or if your credit growth let's start at the highest level. If your aggregate credit growth in an economy is 10% and next year it is still 10%, that sounds awesome. But in fact, that's actually GDP neutral to negative depending on--on where we are at in the model because once you get locked into a rising credit market and you are using credit to fuel GDP growth, then the credit growth has to increase on a constant basis or it becomes negative. Have I captured that even remotely correct?
Steve Keen: Pretty much. The part that sets me apart from mainstream economists and even most Keynesian colleagues is that I was arguing for a long time the total amount of the economy is income plus change in debt. Now, strictly speaking--that's not true. What's the case the demand is turn over existing money plus change in debt. And if you look at most--the reason I was still right with a strictly wrong argument empirically generally right is that most debt that is taken on these days is to buy assets. So, if you have like a 100% of debt purchases or credit purchases were to buy existing assets exactly subprime in the telecommunications bubble beforehand it would be true--the total amount of the economy summing together both the real economy and the financial world would be income plus change in debt.
What you find in the real world is it is turn over existing money plus change in debt. Now, if credit, which is change in debt, is a massive part of your demand, then if it is running at 10 and 15% per annum, it's going to be growing faster than your GDP. You're going to require continuing growing at that speed or they will be given large credit comes relative to actual production there will be a huge slump in demand. And of course that's what happened. So, you can actually have a financial crisis in your economy simply the rate of exchange of debt slows down--it doesn't have to go negative. But of course, it does normally go negative and the United States case, for example, in the 2008 crisis the rate of change of private debt--which is credit--peaked at just over 15% of GDP back in mid-2006 and by the end of 2010 it was down to -5% of GDP. So, that's a switch from positive to negative credit is what really gives a financial crisis like 2008 and, like the Great Depression, their sting.
Chris Martenson: Now, is that a similar concept as the credit impulse which people talked about?
Steve Keen: Yes. It's two fold--it's quite complicated, which is not amazing. But the basic story is debt itself will rise if the change in debt exceeds the change in GDP. And then, when you look at what's happening with things like the asset market, the demand for assets is largely leveraged amount. So, it actually is determining how many physical shares or physical houses you can buy is the new debt, which is the change in debt divided by the price level. You then get a relationship between what is causing change in price level it's the change in the change in new debt or change in the change in debt. So, that's where the credit accelerator comes in. It actually should be called the debt accelerator because it's the second--second derivative of debt that matters for driving asset prices up or down.
Chris Martenson: This is a--
Steve Keen: Hope I haven’t lost to many of your listeners with that one.
Chris Martenson: I’m sure they'll follow along. We’ll put a nice transcript under there as well so they can parse it out at their own pace if they want. This is a global economy at this point in time. Clearly, I mean we had a curious case very early this year where Apple released some negative earnings results and within a matter of minutes we saw the New Zealand dollar tanking against the Yen as a consequence. So, it's this highly interlinked computerized system. Feels like it needs to stay global. What are the chances that the current trade spat with the United States, that this global sloshing of money and a big portion of that coming out of China, what's the chance that there could be a seizure in the system because the global flow has suddenly reversed course?
Steve Keen: That's quite feasible. I don't see an economic crisis coming this time around, as I did last time. But because I to have an economic crisis you have to have a high level of private debt change credit and that's very negative--positive to negative. You've got sort of the anemic level of aggregate, of credit in the United States and most of the rest of the world, that is not going to occur. But you do have financial institutions which are very dependent upon the continued government funding, the QE and so on, who have got lots of bad loans accumulating with the private sector on their books that are masked to some extent by the positive benefit that they are getting out of the Federal Reserve's intervention. So if that intervention falters at any time, that suddenly in--in Warren Buffet's wonderful phrase--makes the tide go out and you can see who is naked or not. So, I think a lot of these financial institutions are relatively naked. They are only kept clothed by what the Federal Reserve is doing and therefore, you haven't got a genuine capitalistic economy here. You've got this weird mish mash where a bunch of conventional neoclassical economists are managing something that has got a closer resemblance to the Soviet Union than I'd like to admit.
Chris Martenson: I totally agree. That's we have a small cabal of unelected people setting the price levels for practically everything. What could go wrong, right?
Steve Keen: Yeah, exactly. Yeah. And I think they are being capitalists about it. That's what amuses me about these jerks.
Chris Martenson: Yeah, I know. Exactly. So, Steve, we're talking to you you're in Europe at the moment, in Amsterdam. So, let's talk about Europe for a second and just how distorted this all seems to be. The world is honestly, I want to talk about whether debt really matters. There is this emerging view, which I think is wrong, that debt and deficits really don't seem to matter at this point. And again, to focus this down to a--a metaphor if you will-I love this idea that the world's central banks have managed to coordinate in such a way that Italian ten year debt is trading with a lower yield than U.S. ten year debt which traditional financial theory tells us Italian debt carries less risk than U.S. debt. Obviously, that's a perversion of the story. So, what's happening there and--and is it possible that the central banks have now become such dominant players that we can't actually analyze debt and price levels in debt like we used to?
Steve Keen: I think that's true. They've become so dominant because they have been trying to rescue a system they don't understand using the tools they have. And those tools, fundamentally that the central banks play with the accounts of private financial sector but not with a real economy. Not with a financial sector. So it is easy to fall into QE. To do the QE the easiest way for it to happen is that the on the central bank's the Federal Reserve's balance sheet you got assets, liability and inequity which is rather immaterial for a central bank, crucial for a private one.
But all they have to do to buy a trillion dollars of bonds off the financial sector each year is to say we are going to put a trillion dollars' worth of money into our liabilities, which is your bank the accounts of private banks at the central bank. We are going to record the trillion dollars' worth of loans of--of bonds you sold to us in return for money on assets on our balance sheet. Bang, they create the money. And they have unlimited capacity to do that so long as people accept their own national currency for payments and in virtually every part of the world it happens until a complete breakdown occurs. How they can go on doing this indefinitely. And therefore you can't speculate on the stock market in America without wondering what the Federal Reserve is doing. And keeping a strong eye on any of their policy changes--any trading position whatsoever.
Chris Martenson: Absolutely. It has really become more important to follow what the Fed is doing than any simply fundamental piece. Now changing of the guard and European central bank. We got Mario Drage, who never saw a problem that couldn't be met with printing being replaced by someone who--and I am just being accurate--not unfair--is, I believe, a convicted felon. So--so they had, they looked long and hard across all of Europe and discovered that Christine LaGarde was probably the best they could possibly find out of everybody who exists. She to me, feels like somebody who the system could count on to basically continue Drage's policies more than probably a best fit for what the world needs at this point. Would you, you know, peering into that the possible things that might happen would you predict more printing by the ECB than less going forward?
Steve Keen: I think there is no choice but to continue printing and the reason for this is quite simple from my point of view. And that is that the central bank by boosting asset prices as much as it is done has become the fundamental underlier of these asset markets. And as soon as they try to reverse the policy it is happening in states where they wanted go from quantitative easing to quantitative tightening. The market is tanked because you reversed the process. Whereas under QE the Federal Reserve is putting money into your balance sheets and taking out income earning bonds. Therefore, you would actually get a decent return as a financial institution you are forced to sell--to buy shares with that money and therefore you are buying shares of currently owned shares which tends to drive the price up. When they go in the reverse direction the Federal Reserve is now is going to be on the sell side of open market operations. They are selling bonds to you. You don't, you have as little cash on hand as you possibly can because you --unless you are a clever speculator looking for the stock market crash today you mainly got shares in your portfolio rather than anything else.
To buy those bonds that now are now being sold to you by the Fed you have got to sell shares. That causes share prices to fall. As soon as it happens, the Federal Reserve goes into panic mode. Oh God, pricing market the pricing they have reversed direction again. I have always called QE a pact with the devil. You can't tell Nostradamus that the deal is over. Rather, you can but Nostradamus is going to have a different idea about it.
Chris Martenson: So, let's play a simple game of so then what. So the central banks ride to the rescue in 2008 after of course rescuing their previous boners that they committed back in 2000 and 1995 and on back. Here they are riding to the rescue so the create asset prices which are now hooked in through a transmission mechanism into the actual economy, so then what? So then they need higher asset prices going forward--so then what? Tell me, where does--where does that game--it feels like there is a conclusion to that game which is it pushes until it breaks. And when it breaks it is very unpleasant. That I show I see it. What are they seeing that's different than that?
Steve Keen: They just think its going, they're hoping that the physical economy is going to revive and grow faster than the monetary economy so that they can actually reduce these gearing ratios and sew these bonds back into a recovering economy. They have a fantasy about equilibrium, and this is the original sin of neoclassical economics is turning what was a modeling shorthand for the founders the Jeffersons and Valralls of the world, and Marshalls almost a religion that equilibrium must be achieved. So, this is built on their models and they simply think they can get back to a normal economy with those equilibrium levels and 2% inflation the 3% growth, 4% rate of interest. So, it's their model world that they are looking at that you don't see. And you are much better for not saying their stupid model world it isn't--it's not even a similacrum of the real world.
Chris Martenson: Wait, Steve, they must know by now because we are way past the time of the second law of thermodynamics--that open systems do not have equilibrium. They know that, right?
Steve Keen: No. They have not a bloody clue about the laws of thermodynamics. I'm just--you that's obviously that's Dorothy Dicks thing; they haven't got a damn clue about the laws of thermodynamics. They wouldn't know you know, they, the ghost of Baltimore could turn up at a Federal Reserve meeting and they wouldn't have a clue who is sitting in the chair. The complete ignorance of economists of complete, physical processes and the law of energy and thermodynamics is why they come up with these fantasy models where equilibrium can apply indefinitely.
Chris Martenson: So, Steve, this is of course near and dear to my heart and we're down to I think the heart of the actual issue here. And I was so pleased to see and encourage to have an economist of your caliber actually begin to tackle the role of energy in economics. Obviously, they have to be linked. And in one presentation I saw you quoted Arthur Eddington who wrote in 1928, that "If you're theory is found to be against the second law of thermodynamics, then there is nothing for it but to collapse in deepest humiliation." Steve, how to please tell our listeners how you began to connect, how you have connected economy and energy together.
Steve Keen: Actually, it goes way, way back because my interest in economics when I was an undergraduate student, when I was a school student and they asked me what I wanted to do in a vocational course. I said I wanted to do economics and engineering. There is no such combination so I was pushed into economics major instead. But I did engineering mathematics in my first year. So, I've always had a background in engineering and physical sciences and physics. It was only six years of lousy science teachers at a Catholic boys' school that ended up turning me into an economist rather than a physicist. So, that's not uncommon. I think it's quite a lot of economists actually end up that way. But I was heavily influenced by the Limits to Growth which I saw as a bit novelist study of the actual interacting feedback systems that determine our physical economy and our ecology. And horrified to see economists like Northouse, specifically Nordhouse demolishing the credibility that incredible study. And I'm denigrating people like Jay Forester in the process. So, I've always wanted to bring energy in and I've always been dissatisfied not just with how economists ignore energy completely, so mainstream economics and post Keynesian for that matter. Both model protectionist involving labor and capital with no energy. But even people who try to bring energy intended to add it as a third factor of production.
And that never jived with me because if you are using a neoclassical what's called Cobb-Douglas production function you have labor, capital and energy as three independent inputs. You can set up the parameters so that energy has zero role or if you set it up according to what's called the cost share theorem which the--the coefficient was raised to a power these different independent inputs to give you constant returns. If you double inputs, you double outputs. So, a sensible constraint on a mathematical model of production.
If you set according to the share of energy in the GDP, you get a sick coefficient for energy at about .07. Now, that means if you do the mathematics of a Cobb-Douglas production function--if you cut energy by 90% GDP would fall about 10 and that just was complete nonsense to me. So, I was always trying to bring it about to say I wonder what this brings this in a fundamental way and the simple insight I got, which is within 10 minutes I turned it into an explanation, both what made the complex function appear to work and what was the weakness as well--labor without energy, is a corpse. Machinery without energy, capital without energy is a sculpture. Both need energy to turn, to create. And so, what you have is rather than energy is independent input to the on an equal footing with labor and capital. Energy is an input to both labor and capital, without which they can't function. And then you get a much more realistic picture where energy plays a critical role in the production of anything. And of course, we are having energy you never convert according to the second law of thermodynamics you can never convert all the energy into work, unless you live in a part of the universe which is at absolute zero. There is no such place. Therefore it all has waste being generated. So, once you have energy as an essential input into production you also say should I waste energy which fundamentally takes the form of waste matter in our production system. Of course, essentially--importantly but not essentially--only being C02.
You have a direct link between economics and ecology. So, that was something I did about three years ago, and I'm now following that argument to rewrite economics from the ground up so it starts with energy as the fundamental input and fundamentally sees GDP as useful work.
Chris Martenson: Yeah, and another concept I pulled from the biophysical economists out there - Otem, et al. it would be the idea that even as energy is showing up into the equation there is an energy return on energy invested in that not to overly complicate this but if you are--this is what we are finding right now the big Gawar field in Saudi Arabia they drill down 1000 feet. Next thing you know you have a thing a well producing upwards of you know 4 or 5000 barrels a year for 50 years. Today we're drilling 20,000 feet total lateral length plus vertical into shale and getting a well that produces a max of maybe I don't know, 800 barrels per day 95% depleted within four years. So, very different energy equation. Yes, the economists out there would say look we still have 100 million barrels of oil on the market. But what we're doing is we're slowly swapping out 100 to 1 energy return oil with five to 1 energy return oil. And, as you mix those two oils in the tank we have just less and less and less to fund our highly complex economic system, which, taken from a book, the Origin of Wealth by Beinhocker--he has this wonderful part where he talks about complexity theory and how complex systems order their complexity to the flows of energy through the system. I'm just saying look, we're going to have less energy flowing through the system, probably less order and complexity which is a great way of saying we'll have a simplifying economy over time. Not an increasingly complexifying economy.
That's the fundamental thing that I think the central banks are pushing for--growth of an increasingly complex world and they don't understand that energy needs to be flowing through that and our sources of energy are degrading over time.
Steve Keen: Yeah, absolutely. I mean there is--it's very complex mix at the same time. I don't think it's necessarily energy that is going to bring us unstuck. I think it's the waste we are dumping into the biosphere that is the main thing bringing us unstuck. But I'm caught in the middle here. I'm not an engineer. I've got a lot of engineering friends and I got a lot of engineering feedback in the work that I do. And I'm finding that the whole EROI, return on energy invested area is quite a, you know, it's a bit of a quagmire as you are a bit aware, Chris. Where you define -- where do you define the starting and ending of the energy input. Where do you find the starting of the energy output? And if you, for example, you just use a nuclear power station and you look at the energy that it takes and the energy it puts out, you get an enormous number. If you then take a look at what is the transmission lines effective sending that energy 1000 KM, then you get a very different number. If you then look at decommissioning, you get a very different number. If you don't bother decommissioning you are simply then whacking at concrete. Same thing applies to the same thing applies to wind and to solar.
So, I'm not sure on this front. So, a lot of EROI cliff, a concept I know you are familiar with where, to maintain a sophisticated society, you need an energy return an energy invested of at least five. And the argument was that oil started the 100, 200 mark which is why it was such a powerful commodity. And the old Beverly Hillbillies. You fire a shotgun into the ground at a rabbit and out comes oil. Okay. We go from that to where you've got to drill 15,000 meters you know into the ocean to actually pull the stuff out then you got a far, far different amount of energy going in to get that energy out. But at the other end the argument was that solar and wind are starting at right about the two or three level. Some people are even arguing they are negative I've seen articles serving that.
I'm now getting--I have to say my judgment is that the various calls I'm getting it appears particularly within photovoltaic and with lower profile even with the big wingspan, the biggest now is 120 meter wingspan wind towers I have seen lower profile ones as well--it may be that the energy return is high like about 20, 30 to 1 and that is enough to maintain an advanced society. The trouble is if you continue doing that and you continue dumping the waste that goes with production into their biosphere and I think that is what is bringing us unstuck.
Chris Martenson: I agree with that, and I totally am very sensitive to the idea that we don't know where to draw the boundaries on the EROI studies. Which is why I make a coffer we just don't know. There is just a few--very few people studying it and they are studying it with very low budgets--very poorly budgeted stuff out of a few academic areas. So they have to use proxies like dollars--it's a mess. Which is why I’d say if I was in charge I would have the department of energy throw $10 billion at a modeling function to figure this out. And what I would love to see is to set up a whole town or city or whatever scale you want. I will give you all the solar panels and wind towers that you want. But you have to replace those with the energy output from those same devices before we have a sustainable system, right?
Listen, we have to wave our hands furiously in that whole direction because we don't know anything. But meanwhile, even Russia has noticed a collapse in the bees; insect populations are down 75 to 80% depending on where we're looking. 98% in the case of nature preserves down in Puerto Rico. There is a worldwide collapse in insects. We're seeing the same thing in phytoplankton. So basic bottom of the food chain stuff as a biologist by training, I will tell you this, Steve, taking out the bottom of the food chain is a very bad idea. And we're doing it.
Steve Keen: Yeah, we are doing it. My analogy again is talking I've got a very strong interest in biological mathematics too, Chris, as you know. My Minsky model is basically a predator prey model. What I see is a predator that is eating not just the prey but also the prey’s food and that doesn't end well. And that's what really scares me about the extent to which this is ignored in economic theory and therefore ignored in policymaking.
Chris Martenson: Yeah. And it gets all the way back to the supply, demand curve. Well, we'll just take the krill out of the ocean because that's what the prices tell us to do but honestly, if we were intelligent, we would not be doing that.
I got to switch gears here because I am looking at the time we're out already and we said we would get there. We need to get there. We have a political cycle coming up in the U.S., lots of calls for MMT. I know that you have for a long time, been writing about the need for a modern debt jubilee. So, let's go there. What's the idea behind modern debt jubilee and what's its relation to MMT?
Steve Keen: Well, the basic idea behind a modern debt jubilee is we’ve far too much private debt to accumulate by allowing the financial sector exercise the rights of being able to create money without exercising the responsibilities that should come with. And what they have done is do the brain dead thing of funding asset bubbles because it's easy to just give somebody money to buy a house. That causes the price of the houses to go up. And then you get nice large bonuses on that. And when the bubble bursts who cares, you already moved onto another company or you have taken out so much in options it doesn't matter to you. So, it's been incredibly irresponsible lending not for producing physical infrastructure but for speculation on the price of assets which your own lending is causing. And then we've had all these people who used to be decent engineers and physicists becoming financial engineers, which is absolutely disastrous for our capacity as a build our way out of the ecological crisis we are facing.
So they have been totally irresponsible and basically set it back to zero. Not quite to zero I wouldn't go that far. But I would like to see the private debt level in America for example, go back to the level it was in 1945 and 1965 was between 40 to 80% of GDP but it's currently running at 150%. And in the one area you can actually exploit the limitless capacities of the Federal Reserve--the Federal Reserve has shown it can create money for QE plus double entry bookkeeping it can create money for the public exactly the same way and make an injection to everybody's bank accounts. Also a technicality on how you might do that to avoid triggering default clauses in bonds and so on. You could say anybody who has got debt, then they--that money becomes an offset to their debt which reduces their effective debt burden. But anybody without debt gets a cash injection which in my case I would actually-you don't want to cause a future inflation surge by pumping all this additional money into the economy. Say, if the jubilee is of the order of 100% of America's GDP which would bring it back to a debt level of 50%, then you could say well that money is used to buy new shares which have been issued by the corporate sector with a specific purpose of canceling corporate debt. We could reset the debt engine for the private sector back to of the order of 50% and then we can have it set as a target, a policy not so we get anywhere near 100% which of course the level we blasted through--in America's case back in 1980 and got to 170% ultimately.
So, I wanted to just: reset the debt clock, take the debt burden off the economy, reduce the size of the financial sector, make the financial sector back into a servant of the physical economy rather than its master, and basically get rid of the rentiers, the main danger in capitalism. Not the capitalists as Marx argued but the runt years are the main danger. They are far too big, far too much power and the result of that ultimately is a sluggishly growing economy for everybody so that the parasites.
Chris Martenson: So, what happens in this model when the banking system which of course, makes its money on having assets on its books which are debts. What happens when those --when the asset side of their balance sheet shrinks by half?
Steve Keen: Well, they suddenly are far less profitable they can pay far less people. They basically sack a lot of people and go back to doing what banks used to do, which is lending the person on Main Street with a good idea. If you look at what is called the FIRE sector, financial, insurance and real estate in the national accounts--at various times the profit levels of that FIRE sector were equivalent to 50% of the profits of the entire American industrial the entire American economy. That is actually a cost. They don't produce anything. It's, one of my students put it very well is the finance sector, profit sector or a cost center. It is fundamentally a cost center. It has gotten far too big. We need to reduce its size. Of course that makes some very popular in banks. But we have got to drastically reduce the financial sector. That's what happened during the Great Depression and that's why when you came out--and the second World War that's why when you came out of it bankers were incredibly meek, subservient characters who were secondary to the industrial capitalists of the day. But as you let more debt accumulate they become over time the masters of the system and that is where we have gone to go, and once that ever happens in capitalism you have a very sluggish economy and you know, as we had during the Great Depression. That's the fate of letting finance get too big. We have avoided it this time because the government is so much larger that its increase in spending countered by the private sector. But it's an unhealthy capitalist economy when you have debt levels that high.
C Yeah, the whole financialization thing it is actually written in my family history. My on my mother's side long line of bankers--they started a bank. My great, great grandfather. When my grandfather was coming out after World War II he was looking to go into maybe the family business as it were. And my father tried very hard to talk him out of it. He said this is a 4% business. It's very high risk. It's not a place for a man to make his mark in this world. That is what banking was back in the 50's for him.
Steve Keen: Which is how it should be. Yeah.
Chris Martenson: Yeah, it should just be your kid holding a little bit of capital and trying to connect savers with legitimate borrowers.
Steve Keen: No. that's not in fact what they do. You create--they create money but you gotta create money for the right purposes not for speculation and therefore you got to have controls on what they can lend to. I would be putting all sorts of controls on banks saying that they can't lend, for example, in terms of household purchases more than 10 times the annual rental income of a property being purchased. Because that would mean at the moment if you and I had the same income and the same savings rate and we are competing over buying the same property--if one of us has a high leverage, a bank would win. So, we have a ridiculous personal vested interest in high levels of leverage. If there was a maximum amount so neither of us could borrow more than 10 times the annual rental of the place we were looking at buying than the one who saved more money. And I want to bring in those sorts of rules to constrain what the banks do.
Chris Martenson: Well, I wouldn't put it that way because my grandfather at the time he was running it and I was talking to him about it that his bank did not securitize stuff. If they made a loan, they held the loan. That's connecting the risk and the reward keeping it in the same place. So guess what, you're much more conservative. So maybe this whole idea of financialization. No securitization. I can't make 100 loans and package them all up and sell them to Fannie Mae. I got to hold them, so I better be sure about my prospects here.
Steve Keen: That would be an improvement. It's not the whole thing but certainly securitization and carriage, the type of behavior we saw in the Big Short and that sort of you know, financial engineering is the sort of thing that was a major factor in the economy blowing up in 2008. It shouldn't have been allowed in the first place.
Chris Martenson: So, I totally get the idea of the debt jubilee. There has been a lot of calls for MMT and some advocates of that coming out. Of course, it is going to be a little bit messy. I haven't seen a really clear proposal that anybody is super endorsed at this point in time. Lots can change but as its been pitched so far and you understand how--what are the chances of MMT, what is it and how does it relate to the debt jubilee?
Steve Keen: Well, MMT in the fundamental sense is an accurate description of the accounting of the monetary economy. And this is why I'm, in that sense, I'm aligned with a lot of what MMT advocates put forward because I simply want to have an accurate model of the way the monetary economy functions. And what MMT fundamentally says is that in a monetary economy somebody's spending becomes somebody else's income. And therefore if you want to look at what the aggregate level of savings is in my--if you are looking from an MMT point of view, it is zero. If you spend more than you earn and at the macro level spending expenditure is income, then the aggregate level of spending is zero. Now that's what they all think about saving money shouldn't be all saved money. There is the other use--if you try to save money what it means is you are trying to accumulate some of the existing money stock by spending less of what you've got on other people. Now, if they continue spending as much as they were-you were they were on you before you made the saving decision, the amount of money your bank account increases is precisely as much as the other accounts fall by.
So if we all try to get a try in saving money, what happens is rather than the amount of money changing by the saving you gotta look at a money creation factor. If I leave money creation out of the picture for a moment. If we all try to save money what happens is we save under the rate of circulation of money. And it’s not savings that increases it's GDP that falls by the desire to save. Now, when you look at it that way, the question becomes well, how are you going to get monetary growth then and physical growth as well if that money growth is financing productive activity. Then you have to say well, who can afford to just save. Can the private sector afford to just save? Can the private sector continue borrowing money from the--the non-banks borrowing from the banks? No. Because they have a debt level they can't sustain. They stop doing it.
Can the government? And the answer is the government can, because the government is very secure but it's backed ultimately by the Federal Reserve, by the central bank. And the central bank can create as much of the national currency as it wishes to do. So, the government can be spending more than it gets back in taxation, financing that through selling bonds, maybe the central bank financing that by buying bonds off the private financial sector. That creates money and the bank therefore the non-banks can save because the government in a technical sense is dissaving because it has the capacity to because it's the only institution in society that owns its own bank.
Chris Martenson: But when I look at MMT it is still to me, I peel it back one layer and it's still operating in this idea that what we need, what we want, what we deserve is growth--more growth. It is constant growth. Now at some point in the future and I think we are close to that already with the insect data that I gave you and other stuff like that--there is a point at which you have to get to an equilibrium, a stable state. Not equilibrium. You have to get to a steady state at some point which can have fluctuations within it. But fundamentally, we have to peel away from the growth paradigm. I don't see MMT even approaching any of that. It still seems founded on the same ideas.
Steve Keen: No, in fact, again, there's a link between what is called the Green New Deal arguments and MMT, as well. So, people are saying we can finance the Green New Deal by the government's capacity to create money. There is not a shortage of dollars that is going to cause us having an ecological crisis. It’s a shortage of engineering devices we need to reverse what we have done to the climate so far that will cause us to have that crisis. So, the question comes--how do you finance it? The same way you financed the war against Hitler. You create the money by financing the firms to make the ships, make the tanks that you then use in the battle. You worry about the accounting also. The accounting is being done through the whole process. You create the money on a grand scale. I am not familiar with the American situation because of the whole confusion when America came into the war, this is when it was funding the UK by the cash and carry scam. But in 1940, the government deficit in the UK was 40% of GDP. Nobody in parliament was saying oh, we can't afford that extra 1% because you don't know how many bombs you need to throw at the Germans. Because if you didn't throw enough you would be speaking German next year and saying Hail Hitler rather than God Save the Queen.
So, under an existential threat and I see climate change as an existential threat, the government's money creation capacity becomes in a sense--in a financial not a physical the magic wand you can use to create all the money you need for the job. It's a question of whether you can get the physical resources for it. So, there is a link between MMT and ecological shift. But I would agree with you. I don't think a lot of people in the MMT are paying sufficient attention to that long run question of how do we survive on a finite planet? What do we do to cope with the load we are putting on that planet's biosphere and ultimately, what is the long-term future of humanity?
Chris Martenson: Well, Steve, this is why I really love a quote I pulled from your Patreon account which says, creating realistic economics for a post-crash world" without defining what that crash is--maybe it is ecological. But we definitely, absolutely need new economics--new economic systems, new economic thinking that incorporates this idea that economics doesn’t happen in a vacuum. And we may well discover that economics itself is a subset of the ecological systems that exist out there. Please tell listeners about what you are trying to do and how they can support you.
Steve Keen: Yes. I left the university sector in October of last year. Largely out of partly retirement age but also total frustration of the way that it becomes sclorotic in terms of economics at least the university sector promotes and extends mainstream economic thought rather than challenging it. So, I went out on my own through the Patreon website, which for those who don't know it is a continuous time effectively crowdfunding a bit like Kickstarter and Indiegogo but rather than once off you sign up to give in my case a minimum of $1.00 U.S. a month a maximum of as much as you'd like. I got somebody giving $1000, as it happens, and a couple giving 300 and about 10 giving about $100 a month. And that then enables me to have pretty much the same level as a professor, which means I can continue taking on the battle into mainstream economics and taking on the battle of climate change, as well, which I find myself in a strange situation of being the most prominent non-orthodox economist in that field. So, what I know is that the public universities, the private universities, the federal reserves are not going to fund the type of research we need to turn over this nonsense and build realistic economics.
So, I'm turning to the public. Yeah, if people want to support my work, they can do it in two ways--one is to support me directly through my Patreon's page, which is profstevekeen the other is to support my software package, Minskey, which I'm extending to make possible to use for biological mathematical modeling of the economy with the accounting model being using what I call Godley tables to handle the financial sector. They can support that through another Paterion.com/hpcoder which is my Minskey developer's webpage. Again, two sites to support me or support my software. Let's get some realistic economics before we stop having a capitalist economy.
Chris Martenson: Absolutely. Please do support that everybody. Profstevekeen. Check it out at Patreon. Steve, thanks so much. Really exciting interview. I have a million more questions. We'll save them for next time.
Steve Keen: Indeed mate.