Friday, 25 November 2016

Steve Keen’s odd ideas on debt.

Introduction.   This article replaces an earlier article I did on Keen’s ideas. That article was defective in various ways. Hopefully the material below rectifies that.

Campaigning against debt is easy because the word debt has negative emotional overtones, and for 90% of the population, emotion is everything while logic and facts are irrelevant. Indeed that problem is even bigger in Germany because the word debt in German also means “guilt”. Thus Germans have an even bigger horror of debt than English speakers.

I’ll start by examining Keen’s “Debtwatch Manifesto” published in 2012 and in particular the section entitled “A Modern Jubilee”. Then Keen’s last ideas on debt are considered.

That “Modern Debt Jubilee” section starts thus:

“Michael Hudson’s simple phrase that “Debts that can’t be repaid, won’t be repaid” sums up the economic dilemma of our times. This does not involve sanctioning “moral hazard”, since the real moral hazard was in the behaviour of the finance sector in creating this debt in the first place. Most of this debt should never have been created, since all it did was fund disguised Ponzi Schemes that inflated asset values without adding to society’s productivity.”

Now the claim that “most of this debt should never have been created” is questionable to put it mildly. In the case of mortgages, which form a large proportion of total lending, only about 1% of mortgages in the UK go seriously wrong. So you could perhaps argue that that 1% “should never have been created”. But that’s just being wise after the event. In other words the idea that there is a lending system which can predict with total accuracy which borrowers will come good is unrealistic. The 1% failure rate in the case of mortgages isn't bad at all.

As to small and medium size enterprises, the failure rate there is TWICE that of mortgages. But Keen wants to see more lending going into that allegedly “productive” sector. This is turning out to be a rather muddled argument!

As for Keen’s idea about inflating “asset values without adding to society’s productivity”, I demolished that point here.

Keen’s next two paragraphs in his Debtwatch Manifest are thus.

“The only real question we face is not whether we should or should not repay this debt, but how are we going to go about not repaying it?"

The standard means of reducing debt—personal and corporate bankruptcies for some, slow repayment of debt in depressed economic conditions for others—could have us mired in deleveraging for one and a half decades, given its current rate (see Figure 12).

Now what’s that about “not repaying” debt? As I pointed out above, around 99% of mortgagors are able to repay their debts. Keen seems to have lost contact with reality there.

The second of the latter two paragraphs argues that assuming a significant proportion of debts are going to be repaid, that will have a deflationary effect, thus we face recession for “one and a half decades”, i.e. fifteen years!

Well it’s true that borrowing is stimulatory (and congratulations to Keen for publicising that point). Plus it’s true that the opposite, i.e. repaying loans is “anti-stimulatory” to coin a phrase, as Keen suggests just above. But if there is a lack of demand caused to a rise in debt repayments, that is very easily dealt with by standard stimulatory measures. So what’s the problem? Darned if I know!

Moreover, it’s a bit odd to argue that because variations in lending led to variations in aggregate demand and thus that we need to constrain lending because exactly the same applies various other constituents of demand, for example exports and investment spending. Do we curtail those because purchasers by foreigners of British goods are not absolutely constant, year after year, and investment spending is not constant?

Details of the “Modern Debt Jubilee”.

Keen starts the explanation of the DETAILS of his jubilee idea as follows.

“A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts.”

But also, so as to make sure there is no discrimination against non-debtors, they get the same amount of money.

Now there is a problem of astronomic proportions there, which is that the average mortgage in the UK is currently around £100,000. So (doing some VERY CRUDE mental arithmatic) assuming half the households in the country have a mortgage and assuming there are two people per household, that means we print and dish out £100,000 to half the population!

Well inflation would go thru the roof! And even if that was spread over a ten year period, that’s still £10,000 to those lucky recipients of government largesse. Inflation still goes thru the roof!

Later on Keen says “Clearly there are numerous complex issues to be considered in such a policy…” Well you can say that again. But there’s an onus on those making novel proposals like Keen’s to solve those “complex issues” isn't there? Or at the very least they should put enough work in to solving those problems that readers are persuaded the idea is worth considering.

Unfortunately Keen does not so much as BEGIN to solve the above Mugabe style inflation problem.

Money going round in circles.

Another problem with the above massive disbursement of cash, is this: who pays? To illustrate with a simple example, assume half the country are debtors and half are saver / creditors and the amount borrowed or loaned by each person is the same, i.e. £X. Under the Keen scheme £X is given to everyone. But assuming demand is to remain constant, an extra £X in tax would have to be collected from everyone (assuming, to keep things simple, that everyone pays the same amount of tax). Net effect: vast amounts of money going round in circles!

Of course the real world is more complicated than in the latter example. But taking into account the complexities of the real world doesn’t alter the fact that the Keen scheme involves vast amounts of money going round in circles.

Jubilee Shares.

Next, there’s a section with the above heading. Keen considers ways of short circuiting the obvious feed-back mechanism that exists with asset bubbles. That mechanism is: “asset prices rise, which makes them a better form of collateral, so people borrow more to purchase more of the asset, etc, etc.” Clearly dealing with feed-back mechanisms is desirable, but I won’t consider Keen’s ideas there.

Full reserve banking.

In the next section, Keen says that full reserve banking might help promote stability, but he is skeptical of it. He says “I don’t see the banking system’s capacity to create money as the causa causans of crises, so much as the uses to which that money is put. As Schumpeter explains so well, the endogenous creation of money by the banking sector gives entrepreneurs spending power that exceeds that coming out of “the circular flow” alone. When the money created is put to Schumpeterian uses, it is an integral part of the inherent dynamic of capitalism. The problem comes when that money is created instead for Ponzi Finance reasons, and inflates asset prices rather than enabling the creation of new assets.”

Well as regards Schumpter’s point that full reserve banking gives “entrepreneurs spending power” etc, of course it does. But that is only a merit if there is no way of providing the economy with “spending power”, and of course THERE IS an alternative, as indeed Keen himself points out, namely having the state print and spend money into the economy as and when required.

Keen’s next criticism of full reserve is this. “My caution with respect to full reserve banking systems is that this endogenous expansion of spending power would become the responsibility of the State alone. Here, though I am a proponent of government counter-cyclical spending, I am sceptical about the capacity of government agencies to get the creation of money right at all times. This is not to say that the private sector has done a better job—far from it! But the private banking system will always be there—even if changed in nature—ready to exploit any slipups in government behaviour that can be used to justify a return to the system we are currently in.”

Well the big problem with that argument is that given a less than perfect response from the state to a recession (and doubtless the state will never be PERFECT in that regard) the plain fact is that private banks JUST DON’T rectify the situation: in fact they exacerbate the problems. That is, commercial / private banks act in a PRO-CYCLICAL manner, not an anti-cyclical manner. E.g. come a recession, private banks far from lending MORE, which is what we would like them to do, actually do the OPPOSITE, i.e. lend less and even CALL IN loans.

Keen’s latest ideas.

His latest ideas on debt (far as I know) are in a Forbes article published on the 9th November 2016 and entitled “To Make America Great Again…”.

This article is along much the same lines as the above “Debtwatch” article: i.e. it claims that debt is THE fundamental economic problem. The second paragraph reads as follows.

“The private debt mound sitting on top of American households and businesses is the reason demand is depressed right now. With that debt mountain weighing them down, firms are reluctant to borrow and invest, while households are reluctant to use credit to consume.”

Well first, it’s very debatable as to whether “demand is depressed right now”: at least unemployment in America is back to its pre-crisis level. Moreover, consensus of opinion is that the Fed will probably raise interest rates next month. On that basis the Fed thinks the economy is near capacity.

Second, the argument that there’s a problem because households and firms won’t borrow more because they’ve already borrowed as much as they think they ought to, is an odd argument. But the Keen solution is that we have vast amounts of money going round in circles for years on end, or more likely decades on end, so that firms and households can then borrow more and get back to where they started! That’s my definition of a farce.

Of course the OBJECTIVE of Keen’s “loads of money going round in circles” scheme is to raise demand, and assuming more demand is required, that objective is clearly justified. But where demand needs to be raised, what on Earth is wrong with standard stimulatory measures: interest rate cuts, fiscal stimulus, helicopter drops or whatever you think is best? 

And finally, please note that in criticising Keen's claim that we need to urgently do something about debt, I am NOT suggesting we don't need to do more about inequalities. In fact those two (debts and inequalities) are to a significant extent SEPARATE problems. That is, not all debtors are poor: there are multi millionaires who have borrowed millions to buy large houses or fund their businesses. And there are relatively poor pensioners who have saved up a few thousand: they are creditors.

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