Dedicated to the reform of economics
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Thousands of years ago, Heraclitus, the dark Ephesian philosopher had said: “It is better to conceal ignorance rather than expose it.” (Heraclitus, Frag. 95) Yet in the field of macroeconomics in the 20th and 21st century this fragment of ancient wisdom has been completely reversed. The financial crisis has revealed an unprecedented institutional intermediation of ignorance on how an economy works. Due to the concerted effort of academics, the media, institutions and politicians we have all been indoctrinated with ideas that exposed ignorance and concealed reality.
It was a couple of years ago when I first came across Prof. Steve Keen’s lectures. In an effort to understand the root causes of the financial crisis, I discovered in his lectures an internally coherent and consistent line of thinking that offered a much more realistic explanation of the crisis. I am not an economist or an expert to make a judgment on the validity of Steve Keen’s contribution to economic thinking, but I am sure that if democracy is to be saved in the country where it was born, the only constructive approach is a new dialectic. I simply had to talk to Steve Keen and to try to get across his ideas and views on Greece. The result was Steve Keen’s first ever interview that appeared in the Greek media.
AN INTERVIEW WITH STEVE KEEN
Q: Nikolaos Karatsoris, A: Prof. Steve Keen
Q: In 2005 you were one of the first economists who predicted the crisis. “The crisis can only be understood from debt dynamics”, you had said in a seminar. Why didn’t they see it coming? Is there something wrong with macroeconomic theory?
A: Neoclassical economists do not include debt in their thinking whatsoever, and this is a particular foible of the conventional school of economics. It emanates from sometime early in the 1950s from an attempt to include supply and demand analysis to every aspect of the economy including the money market; if you are going to apply supply and demand thinking, they have a downward sloping demand curve, so the higher the price the lower the demand, the lower the price the higher the demand, and an upward sloping supply curve. To apply that to the money market you have to somehow argue that there is one group demanding money and another one supplying money and that the intersections of those two functions give you both the quantity being supplied and the price of that money. That’s the theory of loanable funds.
Now prior to that vision of finance coming to dominate, so that trying to use the supply and demand paradigm, which is at the heart of the neoclassical school and to apply that to money…. now before that happened even back in the 1920’s and earlier you can find writers like Arthur Pigou who was the main conservative rival for Keynes with the General Theory. You can see him talking about the supply of money being determined by a bank’s ability to lend and saying that banks can create money simply by creating a loan and therefore creating a deposit. Even in Arthur Pigou’s work you can find the argument that I made that demand is the income plus the change in debt, and you can therefore identify a very strong correlation between change in debt and global economic activity. Consequently the vision, before we got the 1940s-1950s revision of the economics by the American economists, was more realistic about the actual functioning of the money system. Now you have this globally collateral loanable funds model, which means that they simply don’t have to consider what the banking sector does. They treat the banks as what they call intermediaries between savers and borrowers. Effectively, if you like, they regard the banks as the market place in which the buyers and demanders of money meet. There is absolutely no role of the banks themselves in determining that supply. That’s their vision.
Q: Banks have been falsely viewed as intermediaries between savings and investment. Yet banks are credit creators. Is there a need for credit creation in a modern capitalist economy, and if yes how do we reconcile this need with the need to prevent the formation of Ponzi schemes? Is the abolition of fractional reserve banking and monetary reform part the solution?
A: Well, that’s the trouble. I don’t think that alone is the cause of the problem. For example, I will give you an illustration of Islamic Banking. I had been invited to speak at a conference on Islamic banking; and of course the whole idea of Islamic Banking is to prevent the exploitation of the borrower by the lender. If you look at the Quran, you can see that Mohammed was a trader who hated being exploited by the money lenders who financed the ventures. So they find every possible way to say that if you are going to lend money you have to share in the risks, so if the venture doesn’t work the bank doesn’t get their money, which is very very different from the modern situation. When the venture doesn’t work, tough luck, the bank still gets their money if they forfeit the assets of the borrower. So the whole vision is to prevent exploitation of the borrower by the lender, but when I asked this Islamic Banking group where these halo funds were invested, the answer was in real estate. Fundamentally they are using a halo system which is supposed to prevent from exploitation to finance an asset bubble. My point is that even though the Islamic System is designed to prevent exploitation, they were still financing exactly the same source of asset bubble Ponzi schemes that the non-halo ordinary interest-charging finance were funding. So my feeling about abolishing… I don’t say fractional reserve system… but abolishing the capacity of banks to create credit, and then handing that power over to the state, is that there is no guarantee that that lending would not end up going into asset bubbles rather than going into productive investment where we actually want that money to go.
Q: How do we change that?
A: I am not a radical in the sense of being someone who wants substantial social change, because I am very aware that if you have a proposal for a major social change, you really can’t be sure of what will happen on the other side of it. Society is a very complex place. My preference would be to try and set very basic rules, make it difficult – almost impossible – for that positive feedback loop to exist between the level of lending and asset prices. Because the problem is that when you lend money you actually drive up the price of assets. So there is a positive feedback loop between increasing the level of lending and increasing asset prices and that in turn gives you the spiral. And that would apply in any system, even if you have one where the government is creating money and then the banks are lending the money out without actually creating credit. Those banks could still lend to finance an asset bubble and, of course, when the asset bubble broke down, the group that will be blamed for the break down would be the government money creation system and not the banks themselves. We can see that in a parallel right now, they are talking about bailing out Greece, but we all know what they are doing is bailing out the banks that lent to Greece. The money is not going to Greece at all.
Q: What do you suggest?
A: To me, there are a lot of ways which we can break that positive feedback loop. Two ways that I can see to break it, is set up something where you have a negative feedback between the level of lending and asset prices. That’s what I mean when I talk about this idea of the Property Income Limited Leverage, the PILL. The idea being there that if you want to look at it at all times, you have to have an easy way to prevent a property bubble or bring it [the PILL] in when a property bubble has burst. If you already had a property bubble, it would be a way to exclude people who can’t afford to buy in the housing sector in the first place. In places like England, for example, you might need a 400.000 pound deposit to buy a house in London; anybody who has profited out of the boom already, before the boom has burst, can quite easily raise 400.000 pounds from previous property sales. But something on which the maximum amount that can be lent is based on the income of the asset being purchased and not the income of the borrowers and set that out, write that into law; and a similar thing with share prices. I would actually ban margin lending outright. I ‘d say that if you are going to be buying shares, you have to buy shares with your own money, you can’t do it with margin lending. And then I am still not sure about the idea of another proposal I call the “jubilee shares.” That is where you have a certain limited number of times that a share can be transacted on a secondary market after which the share would no longer last in perpetuity. Let’s say that the idea being there that the share can be sold 10-20 times.
Q: What happens to the ownership of the share?
A: It can still be bought and sold. Whoever has bought the share owns the share and lasts indefinitely until the company falls. Whoever owns the share owns it, but after a certain number of transactions, the share changes from a perpetuity into a time-limited share, like a 50 year share. And therefore if you‘d buy it after it‘s been sold a number of times, you are buying an income flow from the dividends for 50 years, but not capital appreciation.
Q: What will happen after the expiration of the time limit?
A: Then it’s cancelled
Q: What happens to the underlying asset?
A: The company itself would still exist. Its share would be cancelled like a share buyback only without any money paid over. What you might even do is a share buyback at the 50 year mark and the person who owns the share at that time would have the original purchase price of the share refunded to them.
Q: You referred earlier to the bank bail outs and to what happened to Greece. We have been bailing out the banking sector at a huge cost for society. The current bank resolution proposals of the European Union treat depositors as shareholders and under certain conditions they will be requested to bail-in failing banks. We have seen what happened in Cyprus. What kind of capitalism is socializing the losses and privatizing the profits?
A: Disgusting! It’s stupid. It’s a stupid idea! It’s capitalism run by the ignorant! They don’t realize that if you actually bail depositors in you are cancelling money. They say let’s ruin capitalism, let’s destroy 40% of the money and see what happens! What happens is a depression. It’s phenomenally ignorant! The one lesson you think you would have learned from the Great Depression is you don’t let deposits sail out of banks, because if the deposits sail out, the money supply contracts. And you don’t go just into a debt induced recession, you are going into a money destruction induced recession. Unbelievably stupid! It just shows the price we pay for ignorance about economics.
[I was startled, not so much by the rhetoric, but by the realization of the absence of similar rhetoric in Greece where these decisions are not condemned as stupid and dangerous.]
Q: Is there a path of exit from those so called “unconventional” monetary policies or is this path a step in the dark?
A: The only workable path exit of exit is, when they stop or reduce quantitative easing, it will mean that interest rates in the long end rise, which therefore increases the cost of borrowing and also means that riskier assets are less attractive than they were beforehand. So what they have actually done by QE, they haven’t injected any money into the economy, there is some way that they can get it in there if they buy off shadow banks, then they do inject money into the economy that way, but then of course it only gets spent on Wall Street assets. So you are likely to have an asset market fall when this is done, I think there is quite a good chance that there will be a stock market fall – a substantial stock market fall in America and globally – when they start reducing QE. But the money itself that the government has built up there, I mean, those bonds that it has recovered parallel to excess reserves held by the banks, all they have to do is sell those bonds back to the banks again and mop up the excess reserves. Now when they do that, the government is going to sell those bonds at a loss, so it is another injection back into the banking sector again. It will be the same like as if it was a repo program, they will buy them back. They sold them (the bonds) at an elevated price and buy them back for a depressed price, there‘ll be another effective monetary transfer from the Federal Reserve and similar Central Banks to the banking sector, more profits for them. But in the process you are likely to see stock markets declining.
Q: If QE, as it has been applied, is not the solution, what would be the effect of tapering?
A: Just basically reversing the trend is asset markets.
Q: This means deleveraging.
A: Ultimately yes. You are likely to have some deleveraging to some extent. People who borrowed to get into the share market will find that they are losing money in share market and will be forced to delever. If you have a margin call -- and there is a huge potential for margin calls now in America, because margin debts are close to historical heights once more -- when that happens the easiest way to get out would not be to liquidate the shares, but to liquidate other assets. This will take the wind out of the housing market as well. There is a credit driven boom going on in America right now in the real economy. That’s why the economy is recovering so much. Particularly business borrowing has risen a great deal. But at the same time, the margin debt started to decline, now a few weeks taken out as well, and the share prices really start to fall over, then you get that what they properly call a positive feedback effect and a negative impact in the downward direction in the share market, as declining margin calls means declining share prices as well. People will find themselves being wiped out from that market. You will have potentially a burning real economy with rising levels of debt for borrowing for some business investment but a declining share market.
Q: Lets’ talk about Europe. In an article last year you proposed that the Euro “is the national currency of a country that does not exist” and therefore it is not a currency; you proposed the Euro becoming the SDR of Europe. If we don’t adopt the idea of a parallel currency, the euro-drachma pegged against the euro after letting it flow for a while, do you see another way out of the crisis for the Eurozone if the Single Market is to remain at least intact, or will the Eurozone eventually break down.
A: I don’t know how people in Greece are coping with the level of unemployment right now as the declining income feeds more tensions in public services. It seems absolutely mind-boggling if people can tolerate that. I think at some point you are going to give rise to fascist forces taking over. The Right does the right thing for the wrong reasons at the right time. That’s my own worry, that you‘ll have at some stage the social pressure getting so great, you will have Golden Dawn [a far right Greek political party] get the sufficient level of votes it takes to form a government and do the usual stuff they do. There’s such a political stalemate in Europe over the need to preserve the Euro as a way of preserving European unity, but the reality, of course, is driving Europe apart. There can also be like a short-term low level revival from the level you were driven down to. You were driven down so far, as it happened in Greece and Cyprus in particular, you get to the level where you suddenly look cheap to people for holidays and for selling agricultural products; so you will get a bit of a bonus out of that. So that you don’t get right at the very bottom, and then you can get a revival from the European Union who can claim credit for it, bizarrely. That might keep you floating along a bit longer, but of course when you are continuing to squeeze people’s incomes and continuing to have such high levels of unemployment, at some point you are more likely to have either social breakdown or see sensible political reform by the current political power
Q: So our options are a national currency, a parallel currency, or there is no future in the Eurozone unless we have some kind of reform towards a United States of Europe.
A: Yes which I can’t see happening.
Q: Austerity for Growth. It seems a paradox. Greece’s nominal GDP has declined by 21%, unemployment has risen from about 8% to almost 28%, loans to the private sector have declined by about 20% from its all-time high, employee compensation has declined by 32,5%, investment has collapsed, direct and indirect taxes have risen to unbearable levels, non-performing loans stand at about 30%, there is a deposit-loans gap of about 60bn euros, that’s about 30% of GDP, and the banks despite the recapitalization are continuing to contract credit, and ratios of both public and private debt to GDP are steadily worsening due to GDP collapse. This is an economy in ruins. Given the fact that our public debt is external and held mainly by Eurozone countries, the ECB and IMF, whether we stay in the Eurozone or exit, is there any viable solution without a significant debt haircut? Wouldn’t currency devaluation exacerbate the problem?
A: I don’t think it would make the problem any worse. That’s a tragic situation you are describing. It’s all being caused by reducing money supply and circulation. You got loans exceeding deposits by that enormous margin, courtesy of the internal devaluation while still maintaining loans.
Q: That’s actually money that fled from the country.
A: Yes, Germany and France mainly. That’s the horrifying picture of the 1930s being replayed now. That is what brought Hitler to power; he refused to pay the debts. By refusing to pay the debts the huge financial burden was lifted.
Q: It’s irrelevant then whether we stay in or leave the Eurozone unless there is a haircut or a debt jubilee.
A: That’s right. Definitely!
Q: Do you think that a haircut is politically viable at the moment given the fact there was a PSI and all the debt at the moment is held by sovereign countries, the ECB and the IMF? Is it politically viable for Merkel to go to the German taxpayer and say that if we want to get out of this mess we have to reduce the Greek debt?
A: I do not think that this is going to happen with the current political leaders. They are all totally obsessed with maintaining the euro. But it is politically viable if somebody wants to break the political rules. If they do it, there’s nothing that NATO can do, nothing the EU can do to stop somebody saying we are not going to pay the debts. That’s it. They are written off. And if they do that, then all the caveats that are part of the bond contracts become operative, so you get automatic default. There’s no way that current political leaders will do it, but there is no way that they can stop somebody else doing it. It breaks the rules.
Q: In the case that Germany or the Eurozone countries do not accept to negotiate the debt, do you think that it is a viable option for Greece to stop servicing the debt?
A: Well, the same way was for Iceland. Iceland did the same thing. Iceland refused to service the debts.
Q: That means an exit from the Eurozone.
A: They had their freedom because they were not part from the Eurozone, but the same thing applies even if you are part of the Eurozone. What they can say is that we don’t get the euro anymore, well that’s ok, we already print our own euros, which you do of course. And we already honor, you know, anybody who pays for an asset by making an account transfer in Greece to somebody else’s account. In Greece it works fine. What they will do is confiscate Greek assets overseas. That certainly you can’t stop them doing, so you have that political issue. But that’s hardly an issue for the working class in Greece. It’s an issue for the ruling class, but not for the working class.
[In the minds of Greek people leading economists who opposed the austerity measures or supported alternative approaches and some even a euro-exit have been portrayed as the demons that either did not understand what was “good” for Greece or were planning the destruction of the European Union. The average citizen in Greece has been brainwashed and this is an obstacle that is worth the effort to overcome it. Shifting the focus of attention from Greece and the EU to the global financial and monetary architecture, to the role of banking regulation and supervision, is a line of thinking that I hope transcends dilemmas.]
Q: Is there a credit boom-bust cycle initiated by capital requirement accords under the Basel agreement?
A: Oh yes! I was sitting next to Bill White at the INET conference in Berlin about 1,5 years ago and the discussion of Basel III came up and he leaned across me and said when the rules for Basel II came across his desk, his heart was faint. He understands Minsky, if not better than me, certainly as well as I do. He said the whole idea about trying to specify which assets were safe was going to lead to leverage of those assets by the banking sector.
Q: Since the preliminary discussions between the Bank of England and the Fed in 1986 that resulted in the first Basel accord, a recurring pattern of national deregulation, supranational regulatory supervision seems to have emerged leading to boom-bust cycles.
A: One thing that Basel did was to encourage banks to sell securitized loans and get them off their books. There is a securitization boom driven by regulation as well. Of course securitization was under the myth that you actually reduce risk by redistributing it, or reduce uncertainty by reducing the ownership of assets that its future value is uncertain. That’s insane. That is what happened. You can’t underestimate the extent to which banks are going to arbitrage asset regulations, but the regulators almost always do. If you rely on regulators to enforce things, first what they are going to do is do it too slowly or do it badly, create rules that other people can then exploit and get around and still not break the law, and ultimately fail to succeed in controlling the people they were supposed to regulate. If you set up something as simple as a judge who can say that if you breach this rule you are in jail, as much as I have some critical attitudes toward the law as well, it’s much harder to corrupt the judges than to bend regulators. There’s something straightforward and simple there on that front, like the idea of the PILL, and like Jubilee Shares, relying on the sanctions for breaching where the judges get to say whether it happens or not. That is more likely be effective than anything regulators are likely to try to do.
Q: An institution like the BIS, not accountable to anyone, can impose banking regulations and effectively ignite deleveraging. On the one hand, it maybe desirable, since the aim is to reduce the risks, but on the other hand, it ignites a credit bust. Is this something that we need or should we transfer that power to institutions that at least have accountability through representation, like the IMF?
A: BIS is the private version of what a clearing house is supposed to be. I ‘d like to see something that brought in the International Clearing Union specifically as a way of enabling international financial transfers to occur in supporting trade, rather than having an organization which tries to regulate the behavior of banks. You said 1986 a while ago, I think 86-87, the crash of 87 and the aftermath of that, when the central banks tried to actively manipulate the economy, based on a completely flawed model of how the economy actually operates. That’s what really gave this asset bubble. We are in complete overdrive. It’s a sign, certainly if you don’t know what you are doing, you are not going to do what you do well. That’s partly the dilemma. Secondly, I don’t think it’s an effective mechanism in the first place. It’s far better if it becomes a way of enabling commerce to occur rather than an attempt to control commerce. Ultimately it leads to situations that people can exploit and create credit bubbles out of, which they‘ve done ever since 1987.
Q: Do we need a bancor as Keynes described it?
A: Yes we do. The absence of that is the major issue why the system became so totally crazy, because you are enabling a national currency to be used for international trade. And that has just basically enabled that particular country to abuse the rules of money as Americans have done,but of course ultimately at its own expense, because I think the large part of why Americas’ manufacturing sector has been denuded is the capacity to buy goods just out of their currency’s commercial strength, rather than out of their economy’s industrial strength. We would have had much less of a mess with bancor than we have with the American dollar being the international reserve currency. That is why I was pleased to see the Governor of the Chinese Central Bank back in 2009 call for something like that. We have to revise Bretton Woods, and please God, not held in America this time. If we have that happening, at least we‘ll be arguing for a sensible system rather than one which is at hand, imperialist, which is what the Americans wanted.
Q: So we need a new Bretton Woods?
A: Yes, but not in Bretton Woods.
Q: “Rand is mad”, you had said in an interview. “Humanity has always been a combination of competition and altruism.” Is there an Ithaca and hope for John Galt, or is it impossible to escape from the hopeless search for the mythical Atlantis?
A: We can get out of it. We need to have a more complex vision of how the economy operates and how society operates than those simplistic notion of people like Ayn Rand and Milton Friedman. And the trouble is we‘ve been dominated by those simplistic notions of a complex system. Those simplistic notions exaggerate the importance of competition and understate the importance of cooperation as part not only of the nature of human society, but also of humanity. We are not homo economicus, nor is society utterly an economic society. A vision of both cooperation and competition is essential to a well-functioning economy. If we have it, I think we can function moderately well. But of course in the meantime the other major crisis we haven’t even come close to addressing is climate change. That’s more likely to force us than anything else to thinking in a cooperative fashion, because there is no way that we can competitively solve that problem. So I don’t think we are out of the woods by any means if we solve the financial crisis. We‘ll just move to the next one.
[This interview ended somewhere here. I honestly believe that if new approaches to economic thinking do not become widespread, at least in my country Greece, then the very idea of democracy will be threatened from the radicalization of the electorate. I would be ashamed of my country's civilization if we yield in our desperate search for solutions to uncivilized alternatives. No matter how idealistic this may appear, I believe that it is the duty of my generation to do everything possible to present to our children an alternative vision for a better future, or our children will rightly so accuse us in the future of doing nothing else but just sitting and watching destruction spreading everywhere. That was my aim. I hope Prof. Keen will be lenient with my ignorance and I do hope that this interview has served its purpose in Greece.]
Thanks to the effort of Alan Harvey, Prof. Steve Keen will visit Greece for the first time in June this year. The Aristotle University of Thessaloniki will host a seminar on debunking economics on the 18th of June. The seminar is organized by Prof. Dimitris Mardas, the Society for Economists and Entrepreneurs and IDEAeconomics. Further details will be announced.
An edited version in the Greek language of this interview appeared in capital.gr on January 29th 2014.
twitter : @NikosKaratsoris