Steve Keen: Avoid the next financial crisis with People's QE and a debt jubilee

If you missed any of Merryn's past interviews, you can see them all here.

Merryn: Hi, I'm Merryn Somerset Webb, editor-in-chief of MoneyWeek magazine and today I have with me Professor Steve Keen. Now, several of you have asked me to interview him and, as you know, I always respond to your requests so here he is with us today. He's the author of Debunking Economics which you will all want to read by the end of the interview, and has a new book coming out soon. What's the new book called?

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Steve Keen: Last few days. Actually last few years is a pretty good way to frame it as well, of course; volatility how unusual. But yes, in my Forbes article I said, I'm asking myself a Groucho Marxist question; I'm in a club; do I want to be here? And the answer is no, because everything the club what the club's motto is, is almost the opposite of what it actually does. It's got a club which talks about inclusiveness, bringing Europe together, promoting peace, harmony and economic growth and it's done almost the exact opposite of all those things because of an ideology which dominates the policy and the framing of the policies of the European Union

Steve Keen: Much more disruptive because if the break that I'm expecting does come and I know Mervyn King has similar sympathies here it could be with a right-wing, proto let's use the word proto-fascist party like the National Front in France deciding to break out of the euro and if people think the change England leaving a set of treaties is massively disruptive and, you know, the beginning of Armageddon as we know it, wait until France or Italy leave. That's much, much more dramatic.

Steve Keen: It's in the London Review of Books. The title of the article is Maastricht And All That and he wrote it within weeks of the signing of the treaty, maybe even before it was signed it would have been publicised before it was signed. And he said that the people who framed this treaty, since they only decided to create a central bank and not a treasury as well and they put these huge limits on what the national treasuries could do, they must believe capitalism is inherently stable.

Since it is not, when a crisis comes along the rules of the Maastricht Treaty and the absence of a redistributive mechanism through treasuries and taxations across countries will force countries in decline to continue cutting spending, leading to a downward spiral, the only escape from which will be emigration or death. He wrote that in 1992 in the London Review of Books and I'm sure people reading thought, what an extremist, how ridiculous, how exaggerated.

Steve Keen: Well, yes, that's the trouble. Because England is in terms of migration that's the trouble because England didn't go down with the euro but it was, because of the European Union it was open to migration from the European regions that were part of the euro then a huge wave of youth who have got no prospect of getting a job in their own countries have come over here to work, all sorts of professions, and it doesn't matter in the City because that means you get cheaper cappuccino; the City's quite happy about that.

But if you're in the countryside or, you know, what used to be the industrial heartland of England and you're lining up for public services which have been slashed under austerity by Cameron, OK, so there's less services even for the existing national population and then suddenly all those other people have rights to the same services and your jobs have been destroyed by the de-industrialisation that's gone with the last 30 or 40 years of globalisation, no wonder people develop racist sentiments towards it, OK. It's unfortunate, it's dreadful but this is the cause.

Steve Keen: The only way that would not be a necessity would be if the eurozone worked. It's clearly failed, but we're trapped into the consequences of a failing monetary union and therefore the sensible decision is to let's get away from it. Then Europe itself has to deal with those consequences because if you think of the level if we look at unemployment figures for Greece and Spain and places like that and they're dreadful, they're 25% of the population and 50% of the youth imagine what they'd be if those people who are currently working as baristas around the city and...

Steve Keen: OK, and if you I mean, I've seen enough of Schauble's policies and enough of his behaviour in public too to think he has just got this total autoliberal belief that if and this is another level of complexity of the ideologies here but the autoliberal philosophy is that free markets work really well but for them to work really well you need strong enforcement of laws and Schauble's there to enforce the laws, regardless of whether they're actually succeeding. And of course they're totally failing. And so for him to make concessions is going against his own philosophy, which he won't do.

Merryn: OK. Now, let's move on to what will happen next in our Brexited economy and let's assume for the sake of argument that we go ahead with it and that these odd anti-democracy moves for a second referendum or a cancellation of the referendum because leavers are stupid let's assume that this doesn't happen and that we go through with the Brexit and that we invoke Article 50, say, in October or September, something like that, we have a two-year negotiation period. What are the risks for the UK there?

Steve Keen: The European Union does. Now, if you look at the average tariff that America faces in exporting into the European Union, it's 2%, you know. If we were back in the 50s and 60s when tariffs were 20, 30, 40, 50% then going from being inside a free trade zone to being outside it could have a serious impact on the saleability of British commodities into that market. 2%; I think it's zero for computers, it's about 10% for cars and about 30% for clothing.

Steve Keen: Which is one of the problems of the English economy frankly because it's made the decision to you know, that it's going to become what they call a post-industrial society and I've always said, yes, there is a post-industrial society, it's called hunting and gathering, OK. I think it's a nonsense to say you can have a genuinely post-industrial society because when we talk services what we're really talking about is producing debt, OK, fundamentally and it's, you know, services; OK, we need hairdressers, we need, you know, coffee-makers, etc, etc, but when people talk services fundamentally you're talking the financial sector.

Steve Keen: Household plus corporate, yes, and like if I so one of the problems of trying to analyse debt, which is a major focus of my economics, is that the data on the financial sector's own debt is really a mess and it's such a mess that I normally don't include it in my figures and neither does the Bank of International Settlements but if you look at the plot this is turning up in my next book if you look at the level of private debt in England from about 1880 through to 1980 it's up and down but it's basically flat-lining at about 60% of GDP.

Steve Keen: That's a result of deregulation. Now, that's what the financial services sector has been and the thing is, that can only continue working as a good business plan so long as you continue riding the rocket to the moon but we, you know, you simply can't do that. You don't get off the planet by levering yourself all the time. You cannot sustain an infinite, you know, debt to income ratio so it hit the wall. That was what the whole financial crisis was about and so...

Steve Keen: Yes, it's actually fallen, as a percentage of GDP and partly in absolute terms it's fallen so the idea that you can have a services sector a service sector-driven economy presumes you can continue selling, creating debt faster than GDP grows indefinitely, and you can't do it. So I think it was another big mistake of the English political scene and this is I'm going to blame Maggie Thatcher now was great for not going inside the euro but disastrous for believing you could have a services-led economy.

Steve Keen: Yes, it's and this is the reason that I'm such a maverick in economics and I was even a maverick to some extent within my own maverick faction of economics. I focus on the role of credit in the capitalist economy and the reason that credit matters is that it's part of demand. Now, when you look at conventional thinkers like Krugman and the vast majority of including Mervyn King on this particular front, though Mervyn has come a long, long way since the experience of the financial crisis.

Steve Keen: He's developed dramatically, OK, and I really, and I appreciate what he did on the Brexit vote, his calmness and sense that no, no criticism whatsoever. But conventional economists are trained to believe that credit doesn't matter because if I'm going to spend money by spend more money by borrowing I've got to borrow it from you; your spending power goes down because you've lent me the money; mine goes up because I've borrowed it from you; the two cancel out in the aggregate; no effect. That's really the mental picture and in terms of a technical model they call it the model of loanable funds.

And it's completely wrong as a description of the monetary system of a capitalist economy because banks we're not borrowing from banks banks don't have a big warehouse of cash out the back, you know, and somebody comes in and says, I want some cash, and they shovel it out the door and therefore... They're spending from that warehouse as well, you know, this is the vision so the bank can spend less so you can spend more and it's garbage.

So the creation of loans creates money and you spend that money so a huge part of the source of demand is new debt and the way that my simple metric and if I go through the logic of it, not with mathematics, I might add, but just simple using tables to show the case in the new book the total demand in the new economy is the sum of the turnover of existing money, which is largely accurately measured by no inaccurately measured by our GDP figures but it's reliable enough so that's...

Steve Keen: Yes, and if we actually linked ourselves to the tills of Iceland and Sainsbury's and Waitrose and so on we can actually get minute-by-minute calculations of what the total turnover of money in the economy is so that's GDP, OK. Now, you add to that credit because your total expenditure is going to be the sum of what you spend out of your existing money plus any new debt you take on and it does not cancel, OK.

So your total expenditure is your income plus your change in debt, which is your access to credit. That gets to the national level; you put the two together and total demand is therefore sum of GDP plus change in debt. It also becomes total income; complicated stuff which I explain in the next book but the basic story is you can say that total demand in an economy is the sum of GDP plus change in debt, private debt.

Now, putting that together, that's why I saw the financial crisis coming, because what you had was, with the level of private debt to GDP rising from 60% back when Maggie was in charge to 200% of GDP shortly after the crisis hit, what you had was this huge increase in debt every year, which the change in debt is credit so at various times it got to be responsible for about say, 20 or 30% of total demand each year was credit.

Steve Keen: Unfortunately it's going to probably stabilise around this level because if you get and this is the great danger of trying to reduce your debt by reducing your spending your spending is a component of GDP and this is what, way back in the 1930s, Irving Fisher called the he called it the I name it the debt dilemma or a paradox of debt, where,as he put it, the more debt is paid, the more they owe because if your and this is certainly in the context of the 1930s when most of their debt was owed by businesses rather than households if you're in debt as a business and you know you're going to go bankrupt unless you pay that debt back then you think, I'm going to cut my prices, drag in the customers to my shop rather than the next-door shop, get the revenue and pay my debt off.

But when you do it the price level falls, OK, and you've got to then finance yourself out of you've got an existing debt which is in money terms; you can only [?] finance that with the turnover of existing money and the price levels drop. So what you get as a result of that is the debt level falls and the GDP might even fall faster so your debt ratio can rise. Now, Japan and this is why I find it...

Steve Keen: Spot-on; good summary. So that's exactly the situation Japan has been in now since 1990 and in Japan's case they went from about they've always had a higher level of private debt because the what do they call that system? The keiretsu system they have where there's a sort of conglomerate of industrial and financial... Most of the financing of industry was done by borrowed money rather than by equity through Japan's revival from the end of the Second World War so they had an average debt level of about 1.5 times GDP until about 1980.

Now, in 1980 they got what they call the bubble economy and it rose ultimately to 2.2 2.25 times GDP. You then had the deflation coming in from 1990 on, declining credit and the debt level fell but it's now fallen to about 1.75 times GDP and it's been there for ten years. It goes up and down, up and down. What it means is on one side of the crisis in Japan's case, I think in the final year of the bubble economy credit was responsible for about 40% of aggregate demand, OK. It comes down to being minus 2% roughly from 1990 on so rather than total demand being GDP plus this huge slab of credit, it's GDP minus this small reduction in credit and consequently that's where their stultified economy has come from.

Steve Keen: Absolutely and this is where and that's why I wrote Debunking Economics as I argue in the preface there that neoclassical economics, which is the dominant paradigm of economics today, is more dangerous to capitalism than any number of left-wing revolutionaries because it's a completely misguided vision of how capitalism functions and if you follow a misguided vision, managing a complex system like or trying to manage a complex system like a capitalist economy, you're going to stuff up. And QE's the classic stuff-up.

Point one violates accounting laws, OK. Banks cannot lend reserves and my hat off to the Bank of England for a wonderful paper they wrote back in the beginning of 2014 or 2015 I think it was 2014 called Money Creation in the Modern Economy. It was basically an open letter to the conventional economists of the world saying, wake up, guys, you have got a totally wrong model of how money's created, banks do not lend reserves, period, they can't lend them. It's like saying, I can use the oil in my car as fuel. No, you can't, the oil in your car makes sure the cylinders turn over, it is not what's powering the cylinders.

So there're two separate circulation systems; the banks themselves have accounts as customers of the central bank and that's what QE's boosting, those particular accounts. That's like the oil because those reserves are then used by banks when people like you and me make some sort of let's say if I sold that book to you rather than giving it as a gift to MoneyWeek, you might drag your credit card or you give me, you swipe your card to buy it off me. You might bank with Barclays; I bank with Lloyds. There's then going to be a transfer of reserves between the two banks; that's what's actually going on. That's like, it's the oil for our personal transactions.

The second one about giving them reserves and making risky assets more desirable; that's true, OK, that has worked to some extent and on top of it and I'm not sure about this but I think it's logically feasible is that banks themselves, having a drop in income-earning assets, which are what their bonds were that they've sold as part of QE, and an increase in the cash, that gives them, you know, non-income-earning assets in place of income-earning assets.

But of course that means everybody in the markets and I feel this when I talk to family offices and things like that they are feeling the stress of the level of their, the value of their assets, depending upon whether central banks continue or stop doing QE and as you were saying earlier, we're talking about the farming sector; it's the same thing; you've got to worry about a subsidy and capitalism is stressful enough without worrying whether bureaucrats are going to change the definition of the level of the subsidy on you or not.

So that has worked to drive up asset values but has it caused a wealth effect? Well, in a sense, yes, it has because in classic Wolf Of Wall Street manner, it's, the pension funds, the stockbrokers and so on have been clipping this and getting, you know, a nice amount of extra income as real cash to them which they then spend into the economy. But it's trivial as a component of the total economic demand.

Merryn: But we also worry that the wealth effect is negative in many ways because very low rates, particularly in an ageing society, very low rates make people feel slightly panicked because they know that if they're getting a very low income and very low yield they need a much higher level of capital. So even though the value of their assets have gone up they still feel obliged to save more and more and more and we know that in terms of, you know, pension savings for people my age, for example; you know, people my age, instead of thinking, oh, well, the value of, the capital value of my pension fund has gone up, we think, oh, my God, I'm going to need quadruple what I needed ten years ago if I'm to have a decent income on retirement.

Steve Keen: Yes, they're not spending so the German pensioners are actually arguing against QE, you know, so if you want to prove something is wrong quote Greenspan saying it's right, OK and there was a Greenspan interview where he quoted a paper, a Federal Reserve paper about how there's a wealth effect from shares, and the paper found there was no wealth effect from shares, the only wealth effect they found was from housing and it was fairly minor.

Steve Keen: Well, there's more I mean, the US is more into the flipping houses game than England is but I think the wealth effect for England really comes out of foreign buying and the scale of foreign buying here and the extent to which people are allowed to buy properties and not live in them and just use them as either ways to hide hot money from, you know, nice, legitimate businesses in Russia and Saudi Arabia and China, is phenomenal

Steve Keen: Yes, it's strange. I mean, of course Australia's got a similar situation of course. Australia and there's the big difference between the Australian market and the English market and that is that in England mortgage debt has been falling. It's fallen quite substantially from its peak and what that means is it can actually go back up again, OK, whereas in Australia I think mortgage debt in England I'm not sure of the exact figures but they'll be in my book but because I'm looking like aggregate private debt is 1.7 times GDP so let's say 0.8 or 0.9 of that is household debt.

But in Australia the mortgage debt level, I think, is 1.2 times GDP; they are so highly-levered that the continuation of that trend is just out of the question and therefore that's got to go down and that will drag house prices down with it. England's still got a capacity for an acceleration of mortgage debt to cause rising house prices so I'm not going to say that I expect a house price in London crash in London but I do expect one...

Steve Keen: In Australia. The only, again, the only salve there is whether the currency effects mean you get more Chinese buyers of Australian housing because, you know, with the whole currency depreciation thing, if you're buying as a speculative investment and they've got a falling you're buying into a market with a falling currency you want to get out of there. That's what happened to the Japanese back in 1990, again in Sydney in particular.

Steve Keen: People's QE would be like a tax refund, if you got a tax refund electronically, the central bank would credit your account with x amount of money, OK, and like in Australia's case, this was done as part of the attempt to soften the blow of the financial crisis when it hit back in 2008. The Australian government gave roughly $1,000 per person who'd paid their taxes that year at that time and that was spent directly into the economy.

Steve Keen: That's possible but what I would use it for is to reduce debt and that's my little twist I would inject the money into people's accounts independent of whether they were savers who had no bad debt or borrowers who had bank debt. If you had bank debt the money goes against your bank debt and reduces the debt. If you're a saver you get a cash injection so one of the I'm basically arguing we need to do what the ancients used to do, we should have regular debt jubilees.

Steve Keen: That's right, so if you go back to the ancient times, the Sumerians were the first ones to bring in debt jubilees on a regular basis and the reason was that there's a beautiful set of cuneiform tablets that describe this that friends of mine have translated and what you find is they effectively show an exponential increase in debt over time and a sort of sigmoidal increase in agricultural productivity; up and then it plateaus.

And then they show a point dot dot dot cut the debt back to zero and start the whole system all over again. And what was happening because you were taking out debt for the buying, buying the agricultural inputs you needed for production and half the time the harvest would fail, more and more people were becoming debt slaves so if you couldn't pay your debt back you became a slave, quite literally, and you worked on the farm of the moneylender.

Steve Keen: They had a big incentive; either you solve the debt problem or you get invaded, OK; fairly dramatic choice. So back in those days, when you abolished the debt the landlords and the moneylenders lost out comparatively but the first way they lost out was rather more painful than just losing the debt, OK. So execution was the other alternative so the moneylenders got used to this and then it became part of the society, that over time you knew that either in seven times seven years 49 years or every time there was a change of ruler all the debts would be cancelled and the debt slaves would be freed, they could go back onto their own farms and continue working again.

Now, of course, in that sort of society there's only a tiny minority that lose out of the debt jubilee lose it's a weird form of loss because you lose money but you don't lose your life and you don't become a slave of another civilisation if you get invaded. But these days there're lots of people who ordinary people who don't have any debt I'm one of them others who have lots of debt and when I start talking about a debt jubilee people say, what about people who only save money, you're penalising them by just letting the debtors off.

Steve Keen: They won't like that, OK, but the responsible role of private banking in a capitalist economy is to fund, to provide working capital for companies that need working capital, to provide money to consumers for large capital consumer items they can't themselves buy out of their income, which includes housing and cars and things like that, and most importantly to actually give you a genuine capitalist system to fund entrepreneurs.

But banks aren't providing working capital. They're providing consumer credit and consumers are very responsible about credit that's not related to housing, OK. The main thing they've got into is, hey, we can sell to people for housing, house price purchases; and the actual lending of the money causes a bubble which then encourages people in and we get these runaway bubbles in private debt and entrepreneurs; they don't fund entrepreneurs for the simple reason that, you know, four out of five of them are going to fold. If you lend to them you'll lose your principal 80% of your principal gets lost, you hang on to 20% and you get interest on 20% of your principal; it's a bad business deal.

So I would rather say, let's make it impossible for banks to cause bubbles in house prices by limiting lending to the income-earning capacity of the asset being bought, OK, which would stop that positive feedback that leads to runaway house prices, but then make it possible for banks to make what I'm calling EELs, which stands for entrepreneurial equity loans so when you lend to an entrepreneur not to everybody of course but to entrepreneurs you take a capital stake, not a debt stake.

Steve Keen: In the business, so if you lend you get, say, 40% of the which is basically combining banking with venture capital because at the moment, if you know, most venture capital firms; they have some of their own equity base, of course, but they frequently are borrowing money from the banks themselves so you have to borrow money from the banks, which creates money, which is part of what the capitalist system needs to expand demand over time.

Steve Keen: They won't happen. I'm getting more reception for a debt jubilee idea than I ever thought I would get. I even discuss it with family offices and I see them thinking about it, which I never thought would happen. But it won't happen, the politicians won't do it and we've seen it in Japan for 25 years; that's what they should have done; they haven't done it. They haven't even thought about it; that's the terrifying thing.

Steve Keen: Our central bank governor came from Canada, so Canada and Australia but also of course China, Sweden, Norway, Korea are all countries which continued borrowing through the crisis. Now, they've got to go through the same phenomenon of reaching a maximum level of debt and going down so credit falls and so I expect a financial crisis in all of those countries, whereas the rest of the world, including England and America and Europe, I describe as the walking dead of debt.

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