We need a “debt jubilee” to fix the economy

Brexit was for the best, but Britain is still the “walking dead of debt”. There’s a simple solution, Steve Keen tells Merryn Somerset Webb…

Watch the full interview here

Will post-Brexit Britain be better or worse than pre-Brexit Britain? How do we reform our banks? Can we avoid another financial crisis? Several of our readers have written to tell me that the best person to ask about all this is Australian economist Steve Keen. So last week I asked him into the office and put all your questions to him.

We started with Brexit. Keen was a "leaver". Why? Because the European Union (EU) is a club that talks about "inclusiveness, bringing Europe together, promoting peace, harmony and economic growth", but it has "done almost the exact opposite of all those things" for ideological reasons. It is also very likely to break up itself something that will make us very glad to be out. "If people think England leaving a set of treaties is the beginning of Armageddon as we know it, wait until France or Italy leave. That's much, much more dramatic" because they have to leave the eurozone too.

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At MoneyWeek we have long believed that the eurozone will have to break up at some point it's just hard to say when, given the EU's strong political will to keep it going. Keen says it has been obvious since day one of the Maastricht Treaty that unless capitalism turned into an "inherently stable" system, it just couldn't last. Since it has not, when a crisis comes along the rules of the Maastricht Treaty were always going to be problematic. The rules insist on a communal monetary policy, but there is no redistributive mechanism. As countries in decline could no longer devalue their currencies, they would instead have to slash spending, making the decline worse, leading to a downward spiral.

Emigrate or die

The only escape, as the most prescient of economists claimed at the time, would be "emigration or death".* The Maastricht Treaty looked like, and has turned out to be, "a collective suicide note by the countries of Europe". The UK has ended up as employer of last resort for the rest of the EU effectively a "release valve" for the failed monetary policies of the eurozone. Youths with no prospect of getting a job in their own countries have come to the UK to work in huge numbers. So as long as Britain is inside the EU, we are as locked into the consequences of failing monetary union as everyone else because we pick up the pieces. So the sensible decision had to be the one we have made "to get away from it" and to make the eurozone itself "deal with those consequences". That matters because there is a "level of denial in Brussels" about the way its own policies "have turned a serious economic crisis into a series of economic catastrophes".

The UK's biggest mistake

So what will post-Brexit Britain look like? Can Keen see the sunlit uplands ahead? No. The UK economy is a mess, Brexit or no Brexit. The main problem here is that we like to think of ourselves as a post-industrial society. But in fact we went through that stage of development a long time ago and we shouldn't be looking for it again "it was called hunting and gathering". You can't make a long-term living on services alone particularly when all you mean by services is the financial sector, and all you mean by the financial sector is debt.

Look at private debt in the UK. From 1880 to 1980 it basically flatlines at about 60% of GDP. Then, just after Margaret Thatcher's deregulation, "it just goes on a rocket ship" peaking at 200% of GDP. Living on debt can only continue working as a good business plan "so long as you ride the rocket to the moon... but you simply can't". Eventually the debt-to-income ratio hits the wall and that, of course, is what the financial crisis was really all about. So the UK skipped one of the big mistakes everyone else made (joining the euro). But it made another big one in believing that we can get by with just a service (for which read financial) economy when we can't.

Conventional economists don't get quite what a big deal credit is, says Keen. They are trained to believe that it doesn't matter because "if I'm going to 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". But this is "completely wrong as a description of the monetary system of a capitalist economy". Banks don't have "a big warehouse of cash out the back". Instead, the "creation of loans creates new money" and hence new demand. So total demand in the economy is the sum of existing money (or GDP) plus any new debt.

If you understood that, then you would have seen the financial crisis coming after a period in which 20%-30% of total demand is credit, you are going to get one in which "people are going bankrupt because they can't pay back their debts, the banks are getting worried about whether their borrowers can continue going; then the lending stops and suddenly your demand goes from a large amount of credit-based demand to a zero credit band or even negative". Then you have a crisis. In the UK, debt-to-GDP has now fallen from 200% to 170%, and it is "still headed down as a percentage of GDP". But we can't "unfortunately" expect it to fall fast from here. That's because of Irving Fisher's "paradox of debt". The more debt we pay down, the lower growth is, and the more likely deflation becomes. And, of course, the more the price level falls, the more debtors have to pay back in real terms and the faster things can get really nasty. This is exactly what has happened in Japan; at the peak of their bubble, credit was responsible for about 40% of aggregate demand. From 1990 onwards that turned into minus 2%, "so rather than total demand being GDP plus this huge slab of credit, it's GDP minus this small reduction in credit and that's where their stultified economy has come from".


"People's QE" with a twist

OK. So how do we fix this? We know what the central banks' answer is quantitative easing (QE). But we also know that QE ("a classic stuff up") isn't working (listen to the audio of our interview on MoneyWeek.com for more on this). It isn't working partly because the mechanism being used to encourage lending is nonsensical. But it also doesn't work because its net effect is to deliver cash to the wrong people. Rising asset prices may cause a "wealth effect", but not much of one. If you really wanted to stimulate demand you'd give extra cash not to stockbrokers and those who already have wealth (only a "tiny fraction" gets spent), but to everyone via "people's QE".

Interesting. People's QE isn't something we at MoneyWeek have been mad for so far. Can Keen really be keen on the idea? Very much so but "with a twist". His version would effectively give everyone in the UK a one-off electronic cash payment. Those with debt would have to pay down that debt with it. Those without debt would just have more cash than before cash they'd be likely to spend. Keen is, he says, really arguing for a "debt jubilee" (a debt forgiveness programme), but one that doesn't leave the prudent feeling hard done by (they get paid too).

This isn't a new concept "the Sumerians were the first ones to bring in debt jubilees on a regular basis". They did it for good reason. People borrowed to buy the inputs they needed for agriculture, but given that harvests frequently failed, the borrowing meant more and more people ended up as debt slaves (working on the farms of the moneylenders). This didn't work for the Sumerians, partly because rising debt levels correlated with plateauing productivity and partly because only freemen could serve in the army; "either you solve the debt problem or you get invaded". They solved the problem: either every 49 years or on a change of ruler, all debts were cancelled. We need to do something similar, says Keen. It shouldn't be hard: our central banks can easily create money, deposit it in bank accounts and set it against existing debts. I can see the merits of the idea if savers aren't penalised and everyone can be persuaded that the payment is permanent but also a one-off (tricky pre-conditions, I admit), why not?

Destroying debt is just the beginning

But would a debt jubilee stop us having another financial crisis, I ask. It won't. For that, says Keen, we will also need to reform the banking system. "The responsible role of private banking in a capitalist economy is to provide working capital for firms that need working capital; to provide money to consumers for large consumer items they can't themselves buy out of their income; and most importantly to fund entrepreneurs." Banks no longer really provide working capital (that's been given over to the commercial paper market). They don't fund entrepreneurs for the simple reason that "four out of five firms will fold". They are providing consumer credit but mostly for housing and far too much of it, such that the actual lending of the money causes a bubble.

So we need to reform the system in two major ways. First, by making it impossible for banks to causehousing bubbles "by limiting lending to the income-earning capacity of the asset being bought". That would stop runaway house prices. Second by making it possible for banks "to make what I'm calling EELs, entrepreneurial equity loans". This would mean them acting a bit like private-equity firms, in that instead of creating money to lend it, they would create it to take equity stakes in the firms in question. This would "force bankers to think, rather than just asking, what's your collateral?"

Do these things, says Keen, and there's a chance that financial crises could be almost entirely avoided. They won't be, of course because neither of them will happen. "I'm getting more reception for a debt jubilee idea than I ever thought I would get But it won't happen, the politicians won't do it. They should have done it in Japan every year for 25 years." But "they haven't even thought about it; that's the terrifying thing".

So expect continued crisis and in particular expect it in all those countries that just kept borrowing while we were going through ours Canada, Australia, China, Sweden, Norway, South Korea. And the rest of us? We will stay as we are now "the walking dead of debt" Brexit or no Brexit.

*Keen recommends looking at Wynne Godley's astonishingly prescient 1992 London Review of Books article, "Maastricht And All That", from which this quote comes.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.