Keynesianism and the Great Recession

Yves here. This is a very accessible piece about both the policy failures of neoliberalism and the shortcomings of Keynesianism. However, I have to admit to not being keen about the use of the term without making clear that “Keynesianism” usually refers to American Keynesianism, and is NOT what Keynes created. Paul Samuelson, who wrote his dissertation on neoclassical economics, along with John Hicks, succeeded despite Keynes’s objections in treating Keynes’ work as a special cases of neoclassical economics when Keynes rejected it (neoclassical economics assumes that economies come to an equilibrium at full employment, while Keynes regarded them as fundamentally unstable).

A minor quibble with this piece is that the Bello treats finance-dominated capitalism as inevitable. While it is a bad evolution we badly need to correct, it didn’t have to wind up that way. As Michael Hudson described long-from in his important essay, From Marx to Goldman Sachs, there were two competing models of capitalism in the 19th century, the industrial-dominated model of Germany, and the finance-dominated one of England. Marx thought it was inconceivable that industrialists, who controlled the productive wealth of society, would let financiers dominate in the long run. But as Hudson points out, one of the unfortunate effects of World War I was that England and thus the Anglo-American model prevailed. Mind you, industrial dominated capitalism would have had its own issues, but Hudson believes that its predation would have been less extreme.

Originally published at Triple Crisis

An Interview with Walden Bello

Keynesianism offered important tools for overcoming the economic crisis, but its application by Obama’s government was too half-hearted and misdirected (going to banks rather than households) to effectively reduce the recession. Clinton paid the price.

This interview with Walden Bello is based on the article “Keynesianism in the Great Recession:
Right Diagnosis, Wrong Cure,” available here from the Trans National Institute.

Q: What were the main ways in which neoliberalism created the Great Recession?

A: Neoliberalism sought to remove the regulatory constraints that the state was forced to impose on capitalist profitability owing to the pressure of the working class movement.

But it had to legitimize this ideologically. Thus it came out with two very influential theories, the so-called efficient market hypothesis (EMH) and rational expectations hypothesis (REH). EMH held that without government-induced distortions, financial markets are efficient because they reflect all the available information available to all market participants at any given time. In essence, EMH said, it is best to leave financial markets alone since they are self-regulating. REH provided the theoretical basis for EMH with its assumption that individuals operate on the basis of rational assessments of economic trends.

These theories provided the ideological cover for the deregulation or “light touch” regulation of the financial sector that took place in the 1980s and 1990s. Due to a common neoliberal education and close interaction, bankers and regulators shared the assumptions of this ideology. This resulted in the loosening of regulation of the banks and the absence of any regulation and very limited monitoring of the so-called “shadow banking” sector where all sorts of financial instruments were created and traded among parties.

With so little regulation, there was nothing to check the creation and trading of questionable securities like subprime mortgage-based securities. And with no effective monitoring, there were no constraints on banks’ build-up of unsustainable balance sheets with a high debt to equity ratios.

Without adult supervision, as it were, a financial sector that was already inherently unstable went wild. When the subprime assets were found to be toxic since they were based on mortgages on which borrowers had defaulted, highly indebted or leveraged banks that had bought these now valueless securities had little equity to repay their creditors or depositors who now came after them. This quickly led to their bankruptcy, as in the case of Lehman Brothers, or to their being bailed out by government, as was the case with most of the biggest banks. The finance sector froze up, resulting in a recession—a big one—in the real economy.

Q: So how did these banks get to be so big and powerful? What drove the “financialization boom” that triggered the recession?

A: Financialization or an increasing preference for speculative activity instead of production as a source of profit was driven by four developments. The first was the abolition, during the Clinton Administration, of the Glass-Steagall Act that had served as a Chinese Wall between commercial or retail banking and investment banking, as a result of tremendous pressure from the big banks felt left out of the boom in trading. The second was the expansive monetary policy promoted by the Federal Reserve to counter the downturn following the piercing of the bubble in the first years of the new century. Third was the government and business’ move to shore up effective demand by substituting household indebtedness for real wage increases. Fourth was the lifting of capital controls on the international flow of finance capital, following the era of financial repression during the post-war period. These developments acted in synergy, first to produce a speculative boom in the housing and stock markets, then feeding on one another to accelerate an economic nose-dive during the bust.

Q: What was the worst impact of the crisis, and upon whom?

A: With unemployment hitting 10 per cent in 2010, working people suffered the most. Although the unemployment rate is now down to five per cent, that fall has been driven less by improved labor market conditions than a falling rate of participation, as discouraged workers withdrew from the labor force. More than 4 million homes were foreclosed. Lower income households, the main victims of aggressive loan sharks, suffered most.

As far as growth was concerned, the recovery was tepid, with average GDP growth barely 2 per cent per annum between 2011 and 2013, less than half the pace of the typical post-World War II expansion. In terms of inequality, the statistics were clear: 95% of income gains from 2009 to 2012 went to the top 1%; median income was $4,000 lower in 2014 than in 2000; concentration of financial assets increased after 2009, with the four largest banks owning assets that came to nearly 50% of GDP.

An Economic Policy Institute study summed up the trends: “[T]he gains of the top 1 percent have vastly outpaced the gains for the bottom 99 percent as the economy has recovered.”
At the individual and household level, the economic consequences of being laid off were devastating; with one study finding that workers laid off during recessions “lose on average three full years of lifetime income potential.” One estimate showed that the income of the United States would have been $2 trillion higher had there been no crisis, or $17,000 per household.

Q: What did Keynesianism offer as a way of responding to the crisis?

A: Keynesianism offered two major weapons for overcoming the crisis. The first and most important was a fiscal stimulus, or deficit spending by government. The second was monetary expansion. Essentially, these were forms of government intervention designed to revive the economy after a collapse of investment on the part of the private sector. They are called “countercyclical” since they are designed to counter the recessionary pressures brought about by the crisis of the private sector.

Q: How were Keynesian policies and strategies applied in the wake of the onset of the recession?

A: The Keynesian interventions were in the right direction. Unfortunately, they were applied half-heartedly by the Obama administration. For instance, the size of the fiscal stimulus $787 billion might have been enough to prevent the recession from getting worse, but it was not enough to trigger an early recovery, which would have demanded at least $1.8 trillion, according to Cristina Romer, the head of Obama’s Council of Economic Advisers.

Expansive monetary policy was always a second best solution and was not as effective as a fiscal stimulus. Yes, cutting interests to zero and quantitative easing—or providing banks with infusions of money—did have some impact, but this was rather small since, for the most part, individuals and corporations did not want to go further into debt but wanted to focus on lessening their debt.

Q: What three things could have been done, “truer” to the spirit of Keynesianism, that would have reduced the recession?

A: First of all, there should have been a much bigger stimulus, one along the lines of Cristina Romer’s proposal of $1.8 trillion. Second, instead of focusing on saving the banks, the government should have devoted resources to assisting the millions of troubled homeowners, a move which would have raised effective demand. Third, the insolvent banks should have been taken over or nationalized and the billions spent on recapitalizing them or guaranteeing their borrowing should have been devoted to creating jobs to absorb the unemployed.

Q: Is financialization still a threat?

A: Yes, even conservative analysts say that the so-called Dodd-Frank reform encourages moral hazard or reckless behavior by banks owing to their belief that when they get into trouble, the government will bail them out.

Derivatives—which Warren Buffet called “weapons of mass destruction”—are still virtually unregulated. And so is the shadow banking sector. The non-transparent derivatives market is now estimated to total US$707 trillion, or significantly higher than the US$548 billion in 2008.

As one analyst puts it, “The market has grown so unfathomably vast, the global economy is at risk of massive damage should even a small percentage of contracts go sour. Its size and potential influence are difficult just to comprehend, let alone assess.” Former U.S. Securities and Exchange Commission Chairman Arthur Levitt, the former chairman of the SEC, says that none of the post-2008 reforms has “significantly diminished the likelihood of financial crises.”

Q: What has been the legacy of the crisis on U.S. politics?

A: One can say that the Obama administration’s failure to reinvigorate the economy after eight years and to reform the banks was the central factor that lost the elections for Hillary Clinton. If there’s one certainty that emerged in the 2016 elections, it was that Clinton’s unexpected defeat stemmed from her loss of four so-called “Rust Belt” states: Wisconsin, Michigan, and Pennsylvania, which had previously been Democratic strongholds, and Ohio, a swing state that had twice supported Barack Obama.

The 64 Electoral College votes of those states, most of which hadn’t even been considered battlegrounds, put Donald Trump over the top. Trump’s numbers, it is now clear, were produced by a combination of an enthusiastic turnout of the Republican base, his picking up significant numbers of traditionally Democratic voters, and large numbers of Democrats staying home.
But this wasn’t a defeat by default. On the economic issues that motivate many of these voters, Trump had a message: The economic recovery was a mirage, people were hurt by the Democrats’ policies, and they had more pain to look forward to should the Democrats retain control of the White House.

The problem for Clinton was that the opportunistic message of this demagogue rang true to the middle class and working class voters in these states, even if the messenger himself was quite flawed. These four states reflected, on the ground, the worst consequences of the interlocking problems of high unemployment and deindustrialization that had stalked the whole country for over two decades owing to the flight of industrial corporations to Asia and elsewhere. Combined with the financial collapse of 2007-2008 and the widespread foreclosure of the homes of millions of middle class and poor people who’d been enticed by the banks to go into massive indebtedness, the region was becoming a powder keg of resentment.

True, these working class voters going over to Trump or boycotting the polls were mainly white. But then these were the same people that placed their faith in Obama in 2008, when they favored him by large margin over John McCain. And they stuck with him in 2012, though his margins of victory were for the most part narrower. By 2016, however, they’d had enough, and they would no longer buy the Democrats’ blaming George W. Bush for the continuing stagnation of the economy.
Clinton bore the brunt of their backlash, since she made the strategic mistake of running on Obama’s legacy—which, to the voters, was one of failing to deliver the economic relief and return to prosperity that he had promised eight years earlier.

Q: In what ways do we need to go beyond Keynesianism to address current economic and ecological problems?

A: I think Keynesianism has valuable insights into how a capitalist economy operates and can be steadied so its inherent instability and contradictions can be mitigated. But, as Minsky says, these solutions do not address the inherent instability of the system. A new equilibrium contains the seeds of disequilibrium. With its focus on growth propelled by effective demand, Keynesianism also has problems addressing the problem of ecological disequilibrium brought about by growth.
The real issue is capitalism’s incessant search for profit that severely destabilizes both society and the environment. I think there is no longer any illusion, even among its defenders, that capitalism is prone to crises, and these days, these are crises that not only stem from the dynamics of production but from the dynamics of finance.

We need to work towards a post-capitalist system that aims at promoting equality, enhances instead of destroys the environment, is based on cooperation, and is engaged in planning to achieve short term, medium term, and long-term goals. In this scheme, finance would function to link savings to investment and savers to investors, instead of becoming an autonomous force whose dynamics destabilizes the real economy. A post-capitalist society does not mean the elimination of the market. But it does mean making use of the market to achieve democratically decided social goals rather than having the market drive society in an anarchic fashion.

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  1. craazyboy

    But Yobs! EMH is more than just a hypothesis. It’s really, really true stuff. Say Paris Hilton or even some squillionaire heir dude decides to spend a little pocket change on a brand new pair of self driving, artificial intelligence, rocket powered yoga pants.

    An enterprising Silicon Valley startup will emerge and, with the help of IPO financing, supply the product ’cause there is demand. It’s that simple!

    1. Clearpoint

      But can they patent their invention, monopolize the market, and defend their obscene profits with an army of New York and D.C. lawyers circling around the money machine? If so, count me in!

  2. der

    We need to work towards a post-capitalist system that aims at promoting equality, enhances instead of destroys the environment, is based on cooperation, and is engaged in planning to achieve short term, medium term, and long-term goals.

    Not going to happen because there is no long-term goal. That pile of derivative crap will keep growing forestalling the day the nothing cancer it’s based on metastasis and brings it down, quantitative easing is a placebo. That’s the medium term. In the short term there’s Silicon Valley’s monopolization model, run by selfish man-boy innovators stroking the egos of old greedy politicians who look down on indebted, seduced spend happy deplorables. The latest video of insecure man-boy Travis Kalanick arguing with and dismissing the views of one of his drivers “Some people don’t like to take responsibility for their own shit.” shows the attitude of the ruling classes toward the 90% deplorable suckers they’re working to con with new “Innovations”.

    The long-term our elites have given up on, smart people they are and as Chris Hedges has said “know what’s coming” as today’s news brings warnings of permafrost gas release. What are our elites solutions? Do as Peter Thiel and buy citizenship to an island nation, or like those smart people who purchased a condo in some mid-western abandoned missile silo? Why they have a doctor and dentist on the condo board has me confused, what no butcher, baker, candle-stick maker? And then what? After Bannon’s apocalyptic melt down come back home and take an Uber ride to your AirBnB where the doctor’s serve up a delicious gourmet feast?

    The Best and Brightest, the ruling class. Time is running out, as the planet burns.

    1. Clearpoint

      When you have a finance dominated economy, the uber ceo is the standard for what the “best and brightest” will become. That youtube video captures the immaturity, selfishness, and arrogance of this child masquerading as a man.

    2. steelhead23

      The underlying problem is that profit has become the dominant measure of individual-worth. Were society to reward people based on their contributions to society, the difference in esteem and renumeration between an elementary school teacher and the CEO of a multinational corp. would be miniscule. Tax policies could be put in place that would effectuate such an outcome, but to even suggest such in our current environment is laughable. Do I hate the rich? No. I merely cannot see their value to society.

  3. Sound of the Suburbs

    If you want things biased in your favour, bias the economics that everything runs on.

    The Classical Economists looked out on a world of small state, basic capitalism in the 18th and 19th Centuries and observed it. It is nothing like our expectations today because they are just made up.
    Adam Smith in the 18th century:

    “The Labour and time of the poor is in civilised countries sacrificed to the maintaining of the rich in ease and luxury. The Landlord is maintained in idleness and luxury by the labour of his tenants. The moneyed man is supported by his extractions from the industrious merchant and the needy who are obliged to support him in ease by a return for the use of his money.”

    We still have a UK aristocracy that is maintained in luxury and leisure and can see associates of the Royal Family that are maintained in luxury and leisure by trust funds. As these people are doing nothing productive, nothing can be trickling down, the system is trickling up to maintain them.

    Adam Smith in the 18th century:

    “But the rate of profit does not, like rent and wages, rise with the prosperity and fall with the declension of the society. On the contrary, it is naturally low in rich and high in poor countries, and it is always highest in the countries which are going fastest to ruin.”

    Exactly the opposite of today’s thinking, what does he mean?

    When rates of profit are high, capitalism is cannibalising itself by:
    1) Not engaging in long term investment for the future
    2) Paying insufficient wages to maintain demand for its products and services

    Today’s problems with growth and demand.

    Amazon re-invested its profits and didn’t suck them out as dividends and look how big it’s grown. Ignoring today’s economics can work wonders.

    The Classical Economists direct observations come to some very unpleasant conclusions for the ruling class; they are parasites on the economic system using their land and capital to collect rent and interest to maintain themselves in luxury and ease (Adam Smith above).

    What can these vested interests do to maintain their life of privilege that stretches back centuries?
    Promote a bottom-up economics that has carefully crafted assumptions that hide their parasitic nature. It’s called neoclassical economics and it’s what we use today.

    The distinction between “earned” and “unearned” income disappears and the once separate areas of “capital” and “land” are conflated. The landowners, landlords and usurers are now just productive members of society and not parasites riding on the back of other people’s hard work.
    Unearned income is so easy, it’s the UK favourite today.

    Most of the UK now dreams of giving up work and living off the “unearned” income from a BTL portfolio, extracting the “earned” income of generation rent.

    The UK dream is to be like the idle rich, rentier, living off “unearned” income and doing nothing productive.
    Powerful vested interests come up with neoclassical economics so that it works in their favour and only bottom-up economics can be easily corrupted. Top-down economics is based on real world observation.

    Their neoclassical economics blows up in 1929 due to its own internal flaws but the powerful vested interests still love it as they designed it to work in their favour.

    Keynes comes up with new ideas that herald the New Deal and a way out of the Great Depression.

    The powerful vested interests don’t want to lose their beloved neoclassical economics and fuse it with Keynes ideas to roll out after the war. This gives them the opportunity to get rid of some of Keynes’s more unpleasant conclusions, generally tone it down and remove all the really obvious conflicts with their neoclassical economics. The only real Keynesian economics was in the New Deal.

    When the Keynesian synthesis fails in the 1970s, they seize the opportunity to bring back their really biased neoclassical economics.

    It still doesn’t work of course.

    It’s reliance on debt based consumption and debt based speculation, tend to end in debt deflation, e.g. the Great Depression, today’s secular stagnation.

    Today’s secular stagnation is only being achieved by the Central Banker’s pumping in their trillions to stave off debt deflation and there are plenty of asset bubbles still to burst.

  4. Sound of the Suburbs

    Two halves to make a whole.

    Supply side economics – when inflation is too high and demand exceeds supply
    Demand side economics – when inflation is too low and supply exceeds demand

    Today’s economics was a solution to what went before it, as Keynesian capitalism had ended in the stagflation of the 1970s, but it was far too extreme.

    Looking back with two assumptions:

    1) Money at the top is mainly investment capital as those at the top can already meet every need, want or whim. It is supply side capital.
    2) Money at bottom is mainly consumption capital and it will be spent on goods and services. It is demand side capital.

    Pre-1930s – Supply side economics leading to:

    Too much investment capital leading to rampant speculation and a Wall Street crash
    Too little consumption capital and demand is maintained with debt.

    Leads to Great Depression and the debt deflation of an economy mired in debt

    Post-1930s – Demand side economics leading to:

    Too little investment capital compared to demand, supply constrained.
    Too much consumption capital, leading to very high inflation.

    Imbalance causes stagflation.

    Post-1980s – Supply side economics leads to:

    Too much investment capital leading to rampant speculation and a Wall Street crash, asset bubbles all over the place.
    Too little consumption capital and demand is maintained with debt. Global aggregate demand is suffering and with such subdued demand there are few places for real investment leading to more speculation.

    Leads to the secular stagnation of the new normal, the assert bubbles have yet to burst.

    Maybe it’s just the balance between supply and demand necessary to achieve that happy medium.

    Two halves to make a whole.

    1. Sound of the Suburbs

      One half at a time:

      Pre-1930s – Supply side economics – Runs into the debt deflation of the Great Depression.

      Post-1930s – Demand side economics – Runs into stagflation.

      Post-1980s – Supply side economics – Runs into the new normal of secular stagnation as the Central Bankers manage to stave off the under-lying debt deflation.

      1. Sound of the Suburbs

        When the system stays the same for too long it is gamed.

        Demand side economics

        The goal is full employment and workers game the system through unions constantly going on strike for ever more petty demands.

        Supply side economics

        Bankers game the system as they are insufficiently regulated.

        This time they have come up with:

        1) An asymmetric reward structure where there are bonuses for profits and no penalties for losses. They are incentivised to blow bubbles.

        2) The Greenspan and Bernanke put encourage ever more reckless behaviour from the stock market crash in 1987.

        3) TBTF – just go crazy, we will get bailed out.

        1. Sound of the Suburbs

          I probably missed the most important one:

          4) We are guided by signals from the markets, so the bankers rig every market they can and the Central Bankers inflate the markets so they produce no meaningful signals.

    1. OpenThePodBayDoorsHAL

      Separate money and credit. We have a ridiculous system that requires credit creation in order to create money, eventually too much credit is created, but instead of that just being a banking crisis it’s also a monetary and economic crisis. Free your mind a little. Just separate the two.

  5. Paul Greenwood

    German Capitalism was State-sponsored. Siemens & Halske were based in Berlin and lived off State contracts for railways, telegraphs. French Capitalism was State-sponsored. English Capitalism was sponsored by Discrimination against Congregationalists, Quakers, Unitarians, Baptists who were outside the Church of England and could not therefore go to University or enter Professions under Test & Corporation Acts 1665. They had to enter Trade. Hence Cadbury, Rowntree, James Barclay, Samuel Lloyd were Quakers – the latter two forming banks.

    Siemens created Deutsche Bank. As for Finance in Germany, Bleichroeder was Bismarck’s banker – the Bauer Family of Frankfurt became Rothschild. The Finance in London was largely German immigrants – Kleinwort Benson, Sassoons, Cassel etc.

    Britain ultimately lacked investment opportunities because of Free Trade letting competitors export goods into the UK market but tariffs preventing UK exports to USA, Germany, Russia, France etc. Hence Capital was exported building huge foreign investment portfolio through The City – liquidated in 1st World War

  6. Anonymous

    ‘When the subprime assets were found to be toxic since they were based on mortgages on which borrowers had defaulted, highly indebted or leveraged banks that had bought these now valueless securities had little equity to repay their creditors or depositors who now came after them.’

    Interesting interpretation. Unfortunately it bears little relationship to what actually happened. The financial crisis was a repo crisis. Most collateralized mortgage obligations had plenty of equity to cover default losses. Unfortunately, they were by nature opaque and hard to analyze quickly, and like a murmuration of birds, everyone zigged at the same time, so there were no buyers. The repo aspect of the crisis was what really counted. Suddenly repo lenders refused to lend. Investment banks once had longer term financing in place, but this eroded over the several years prior to the crisis. See Cohan ‘House of Cards.’ Also Ed Conard’s ‘Unintended Consequences.’

    1. JEHR

      Anonymous, you are forgetting the role of the massive sub-prime mortgage fraud that the banks initiated and then the banks foreclosed on those who had bought the offered mortgages rather than re-negotiate new mortgages. Forget repo; remember the fraud: forget opaque and hope for transparency which was in short supply during the crisis. It’s all about the fraud, you know.

    2. justanotherprogressive

      Hmmmm…..let’s see if I understand you correctly. It appears that when everyone thought they were buying lunch, they were buying sh*t sandwiches. So the problem wasn’t that they were being sold sh*t under another name, the problem was that they weren’t willing to buy that sh*t? So if they’d have been willing to eat sh*t instead of what they thought they were going to get, everything would have been hunky dory? Ah…..lunch, sh*t, but it’s all the same, huh? Anything for a buck?

    3. Yves Smith Post author

      This is not correct. I wrote about this in sordid detail in ECONNED, with the details of the structures, the amounts, and who was exposed.

      Subprime CDOs (more accurately, asset backed CDOs, which at the time happened to consist heavily of BBB- RMBS exposures) were a significant portion of repo collateral. They went almost without exception to zero.

      Those exposures wound up disproportionately at heavily leveraged, systemically important, and tightly coupled financial institutions. The Eurobanks loaded up on ABS CDOs because their trader bonus formulas highly incentivized it (see discussion of “negative basis trade”). AIG and the monolines were as we know heavily exposed. US investment banks were heavily exposed by virtue of either being stupidly heavily involved in subprime CDOs at the worst moment (Citi and Merrill, I explain why/how), Lehman and Bear by simply being weakly capitalized second tier investment banks that tried getting to be first tier by going way overweight in total risk terms in RMBS and doing a bad job of risk management (Bear by extending too much in its warehouse lines to originators like IndyMac and New Century as well as being a large CDS player; Lehman by taking on too much risk everywhere, witness its obvious balance sheet problems in 2008). Morgan Stanley also had a weak balance sheet and big CDO/RMBS exposures, see AIG trial for details; Goldman was heavily exposed to ABS CDOs by having too cleverly trying to pick up extra margin by brokering them to Middle Eastern investors, leaving them exposed when their AIG hedge was gonna fail.

      Yes. repo was the proximate cause, but contrary to your claim, a lot of the collateral was no good and that was why the repos were not rolled.

      1. skippy

        Amends…. Yves…

        Risk controls were shite and industry made its own bed…. the rest is just a battlefield post mortem….

        disheveled…. which has more grounding in biopolotics pushing ideological outcomes than excruciating analytical financial misgivings….

  7. Anonymous

    People who advocate reindustrialization and manufacturing are out of their minds. Manufacturing margins are shrinking everywhere. China and Germany are going to be in deep trouble. Bruce Greenwald, of Columbia Business School, says that in fifty years most of the things that you buy will be made within fifty miles of your home. Actually, they may be made in your garage, by you, and you may not ‘buy’ them, per se, so much as buy the raw materials and make them. What’s that likely to do for manufacturing jobs?

    1. cnchal

      >Bruce Greenwald, of Columbia Business School, says that in fifty years most of the things that you buy will be made within fifty miles of your home.

      Anybody can say anything. Even nonsense.

      1. Benedict@Large

        That 50 mile radius is not only true; it’s obvious. Fifty years from now, all of our roadways and bridges will have crumbled, and so the transport of finished goods beyond 50 miles of their manufacture will be nigh on impossible.

        Of course the transport of raw materials from their origins to their points of refinement will also be similarly limited, which means that most of what most of us use will be made out of sticks.

    2. justanotherprogressive

      I’m sitting in my kitchen looking at all the things that are manufactured, from my fridge, to my clothes, to my car, to my floors, to the farm equipment I can see outside my window, etc. And heaven knows none of these things last as long as they used to, so yes, I am going to have to replace all this some day as is the farmer…..
      So yes, there will be manufacturing jobs in the future, and not just within a 50 mile radius. Perhaps when the actual economy gets better for people in the lower 90%, they will be more willing to spend money on manufactured products. But in order for their economy to get better, they are going to have to be the ones doing the manufacturing, aren’t they?

  8. Sound of the Suburbs

    Derivatives are the biggest threat to the financial system.

    James Rickards in Currency Wars gives some figures for the loss magnification of complex financial instruments/derivatives in 2008.

    Losses from sub-prime – less than $300 billion
    With derivative amplification – over $6 trillion

    It was the derivatives that really did the damage; derivatives were the mechanism that allowed a housing bust in one nation to infect the global economy.

    Derivatives were used as leverage to increase bonuses on the way up and losses on the way down.

    The derivatives market is now bigger than ever, no sensible regulations have been put in place since 2008.

    Where does the real danger come from with derivatives?
    Jim Rickards was at the top of LTCM when it collapsed in 1998 and saw how the collapse in a link of the derivative chains turns losses, from nett to gross within the system.

    Everyone panicked as it was impossible to gauge the size of the losses.

    When Lehman Brothers collapsed in 2008, everyone panicked as it was impossible to gauge the size of the losses.

    The same problem ten years later and the same problem will happen next time as no regulations are in place. Everyone still believes the risk with derivatives only comes from their nett value as they have learnt nothing from experience.

    Credit Default Swaps are an unregulated insurance product that bought down AIG in 2008, the largest insurance company in the world. They took the insurance premiums and didn’t put anything aside in case these insurance policies had to pay out as they weren’t regulated.

    CDSs are the most dangerous of the derivative products, they bought down AIG and it all happened in a division in Curzon Street, Mayfair in the UK.

    Warren Buffett points out further problems back in 2002:

    They are zero sum bets, so why do bankers love them?
    Both sides think they are taking the right side of the bet and both sides can post profits until that future bet is realised. They are great for bonuses.

    They don’t incur any costs up front and allow for enormous leverage, they are great for bonuses.

    Derivatives are the transmission mechanism for crises in one part of the world to infect the whole global economy.

    They interconnect the major banks in a way that has devastating consequences should one of them fail, this has already been demonstrated by LTCM in 1998 and Lehman Brothers in 2008.

    The nett losses turn to gross losses within the derivatives chains and the losses are incalculable as these chains are opaque and hard to trace.

    We know the biggest threat to the financial system; will anyone do anything about it?

  9. Kurtismayfield

    First of all, there should have been a much bigger stimulus, one along the lines of Cristina Romer’s proposal of $1.8 trillion.

    I was just reading accounts of the events leading up to the stimulus package, and it seems Ms. Tomer was told time and time again that her stimulus proposals were politically impossible. Is there actual evidence that Obama ever saw that 1.8 trillion figure? According to Scheiber’s book, Summers kept brushing off Romer’s numbers.

    If so, the important economic advisors never wanted to fight for what was necessary at a time when a majority of the US public would have gone along with anything. They really are just a bunch of careerists.

    1. Grumpy Engineer

      I have a hard time taking anything said by Christina Romer seriously. After all, she was one of the authors of the infamous ARRA justification report that predicted a 10% peak unemployment rate without the stimulus and a 8% peak unemployment rate with it. That prediction assumed $800 billion in spending and tax cuts, and we got that $800 billion. The unemployment rate shot past 10% anyway. [Additionally, the return to a 6% unemployment rate took twice as long as predicted and only reached that level because of a plummeting labor force participation rate.] The failure of the predictions in the ARRA justification report were truly epic.

      Competence matters. The economists working for the White House (Romer among them) didn’t have it.

      This is part of why Trump won. The ARRA justification report promised a glorious V-shaped recovery with 300k to 500k jobs per month. We didn’t even average 200k per month. The ACA promised cheaper health insurance by $2000 per year. Premium rose sharply instead. When you implement grand new plans, those plans need to ACTUALLY WORK!!

      1. KurtisMayfield

        It sounds like Ms. Romer wrote a report which matched the exact amount that her bosses were going to get from Congress. So she was giving cover for something that was already decided.

        And the ACA is a pile of crap that anyone being involved with should be ashamed of. Unfortunately since the Federal government is completely captured by the renter’s there is zero chance of reform without a complete political revolution.

      2. Yves Smith Post author

        Summers agreed that Romer’s analysis was correct, and Summers is the last person to say that sort of thing. It’s in Ron Suskind’s book Confidence Men. He nixed it for political reasons, not economic ones.

        Is it not hard to imagine that Romer was pressured to create a model to sell the deal? Why would her second model be so different from her earlier one otherwise? That happens all the time in the private sector. If you haven’t seen it, you haven’t been looking.

        1. Grumpy Engineer

          So either Christina Romer is incompetent and wrote up a flawed analysis that didn’t come true, or she knew that the plan would fail and knowingly wrote up the report anyway. To be presented to Congress as justification for the ARRA. To quote FindLaw: “According to the United States Code, title 18, section 1001, a person who knowingly or willingly makes a material statement that is false, or fraudulent, to the feds, is guilty of a crime.

          Intentionally lying to Congress is a big deal. Especially when it results in large-scale and deeply-flawed legislation being signed into law. If Romer knew better, she damned well should have stood her ground.

          1. Yves Smith Post author

            Oh, please. Have you ever worked in the real world? Economics forecasts are wildly inaccurate once you go past six months. Anyone who does macro models will tell you that.

            Have you actually every built a financial model? The results vary by +/- 5X, often even 10X depending on the assumptions made, with assumptions all in reasonable ranges. I’m sure macro models are as bad. And if you are familiar with Poincare’s three body problem, you’ll separately know that modeling in a system of any complexity can never be accurate.

            The CBO routinely does knowing and regularly does way worse stuff all the time, violating its own rules for preparing forecasts and no one has ever proposed going after them. For instance:


  10. Watt4Bob

    People keep forgetting that a large portion of that $781 billion was in the form of tax credits weighted towards the usual suspects.

    And since the MOTU never let an emergency go to waste, the scrum at the trough resulted in the actual stimulus being even more anemic than it is portrayed.

    1. grayslady

      Here in Illinois, which received the second or third highest amount of stimulus dollars, most of the money was spent on bridge and road repairs. Yes, those repairs provided some construction jobs, but, otherwise hardly served to promote the economy for ordinary people. The only really large project to receive stimulus money here was the destruction of a massive, abandoned Outboard Marine plant sitting right on the shores of Lake Michigan. The building was dangerous–and an eyesore–and occupied prime real estate. Unfortunately, what remains on the site is a low level of rubble. Apparently, there isn’t enough money, or interest, in developing the land to provide jobs, recreational space, new living accommodations–anything that might improve people’s lives. In other words, the stimulus was used to repair the old and crumbling, but not to generate new opportunities.

  11. Lyle James

    Here’s a conundrum which baffles me: Bello writes (as have many before):

    “These developments acted in synergy, first to produce a speculative boom in the housing and stock markets, then feeding on one another to accelerate an economic nose-dive during the bust.”

    So we did have our bust in the real estate market, here in California. My own property, purchased in 2005, dropped about 30% in value in 2008 from its market high in 2007.

    It’s nine years later — and my property value is now back up to its 2007 value. So is Los Angeles (and other cities no doubt) back in a “boom” that is inevitably headed again for a “bust”? It seems to me the economy is worse now than it was in 2007, and if these prices were an unsupportable boom then, why wouldn’t they be now? And yet we are (so I’m told) in a period of rising interest rates and tight credit, two things absent the last “boom.” I’m befuddled.

    1. susan the other

      I think Picketty Capitalism has been going on so long that the GFC was caused by the labor classes being deprived too long, then the banksters realized it and tried to resuscitate them but it was too late and because the stimulus was too small even the cure got caught in the implosion…

    2. JerryDenim

      All of the desirable neighborhoods in LA are now well above their 2007 valuations. It seems like pure madness. The way-out exurbs of the Antelope Valley and the Inland Empire are still lower but almost everything in LA city limits is considerably higher now than in 2007. Median income for normal Americans is still lower than in the year 2000, but yet no one seems to think the market is in another bubble? I share your befuddlement. I live/rent in LA and I am sitting on a good chunk of cash I would like to put towards purchasing a home, but I can’t bring myself to pay $600k for a 2 bedroom, 1 bath, 1200 square foot, 1950’s shit box that some jerk is trying to flip for a $200,000 profit. I’m still hoping for another housing crash. The fundamentals of this market are rotten and prices need to come down before I consider tethering myself to a large, long period mortgage.

    3. Gman

      Housing is not just about fulfilling our basic human need for security and warmth, but also our innate powerful tendencies toward aspiration and speculation.

      Sure it is our house, our home, our security etc but for most of us mere mortals it is our biggest financial outlay and has increasingly come to be seen in investment terms.

      Thus over time property has gradually displaced gold as the major store of wealth, and this fixation has clearly been exploited accordingly.

      Crucially it is also one of the biggest and most effective means for the debt creation, through mortgages and their numerous spin offs, that underwrites and drives most modern economies.

      So apart from its obvious practical uses, property fulfils many other functions within economies, many of which used to be filled by gold ie asset backed promises to pay, but without its numerous obvious limitations. We can’t keep finding or creating more gold to keep up with debt/credit expansion, but we can keep building more houses, or creating or exploiting more desirable environments for them for example.

      Equally as important, and unlike gold, government can regulate supply. This ensures that demand ideally outstrips supply to pump the sometimes apparently illogical price inflation that keeps people chasing the horizon and thus keep feeding debt/money into the system.

  12. LIBRE

    Seems like there should be the discussion that there are two competing theories running simultaneously here in the US and much of the EU. My understanding of JMK’s theory is that after the expansion of debt and other financial stimulus to get us out of a recession, that after the recovery Keynes called for paying off debt through generating surplus… that we retire debt in the form of higher taxes until we reach equilibrium. But that never happened. You overlay the Neoliberial macro ideology and voila we get tax cuts to the wealthy instituted by Reagan and Bush43 and austerity for everybody else, exactly the wrong medicine. Compound the growth of debt by trillions of dollars spent on never ending wars. The partial embrace of supply-side policy for 35 years accelerated growing government debt, thus causing subsequent economic crisis.

    It is as if our economic policy leaders are bipolar or schizophrenic. Between this mishmash of conflicting policy and accelerating the uncoupling of labor from capital and wealth creation, inequality has become endemic and without change will become much, much worse. Just wait till the BLS U-6 participation number drops to 40% as millions of jobs cease to exist in the next 20 years while 80% of the wealth will be held by a handful of people. In this “free market” casino capitalist system with its insider trading, zero sum wars, and disregard for collateral damage, survival will only happen for a few. It will be ugly for those trapped in the Kansas silo. Little did George Miller realize in the late 70’s that his Mad Max movie would be a documentary.

  13. shinola

    Let’s see – A gambling addict makes reckless bets using credit and loses big. His Uncle Sam bails him out and admonishes him to never do it again but does nothing else to deter future bad behavior.

    The casino is still open for business, offering unlimited chips on credit.

    What can one rationally expect to happen?

  14. susan the other

    Is Walden Bello an Argentinian by any chance? He sounds like my ancient boyfriend Ezekiel who was the smartest, funniest guy I ever. And he always made fun of me, my idiocy, and the USA for thinking we were the only answer for humanity. I loved him, but I was a dummy and I loved him too late. As for this delightful article, it’s better than butter dumplings, I loved it too. I won’t elaborate all the points. It was great. I’m pondering how wise it seems to demand a post capitalist society which uses the market to achieve democracy and environmental justice – but I definitely do think it’s time has come and we are ready to go forward with this idea. Thank you for posting this. (versus both financial and industrial capitalism which both fail to address the shitstorm we are facing).

  15. sunny129

    ‘The real issue is capitalism’s incessant search for profit that severely destabilizes both society and the environment.’

    Good Luck, fighting against powerful CRONY Capitalists running the Country!

  16. sunny129

    ‘The real issue is capitalism’s incessant search for profit that severely destabilizes both society and the environment.’

    Good Luck, fighting against powerful CRONY Capitalists running the Country!

      1. Adamski

        I should’ve said I’m in the UK. No luck, gonna get it secondhand from Biblio. Sorry for lack of royalties then Yves.

  17. Kalen

    Another excellent, very succinct and up to the point expose of Keynesianism, a condemned by corporate economists, out of fashion economic theory with plenty of experimental foundations. Mostly the so-called ” direct government investments into the mainstream economy as a methods of increasing an aggregate economic demand was hypocritically criticized as detrimental to free markets and free trade, while the same investment in Wall Street financial instruments was welcomed.

    Here is another interesting unique, take what is or may be so-called demand side economics in the context of Keynesianism which only deals with a fraction of the issues of the economy in a deflationary spiral.

    An excerpt from:


    “The Supply Side Economics (SSE) did us all. Yes. Under this benign name the SSE represent an extreme radical and dangerous ideology based on the unfounded (or rather borrowed) believe that “If we build, they will come” supply side fantasy that implicitly assumes that the real demand (nominal demand minus weighted debt incurred while producing the demand) does not need not be of any concern to the economic, financial and political decision makers, spelling the decades of doom to the people who work for living and created a paradise for the parasitic rent seekers, financial oligarchs and their government cronies.

    The SSE (Supply Side Economic) was presented in the early seventies as an alternative to the Keynesian Theory that supposedly was concerned about the Demand Side Economics (DSE) but in fact it was not [only tangentially]. It cared mostly about the so-called aggregate demand stimulation initiated generally through the government investment policies leaving the task of “real demand” creation on the shoulders of the working people through the organized labor actions and leftist political movements lobbying the government and imparting on the government fiscal policies in a way beneficial to the labor and restricting the power of economic elites.

    For the true demand side economic we would need a set of fiscal and economic and trade policies that would build up the institutional support for completely different, non financial, assets classes such as: the labor asset class (LAC) and the natural environment assets class (NRAC) [and more]. The economic, fiscal and monetary policies of the government in the DSE are [suppose to be] dedicated to maintain the fair value and stable growth of the above asset classes while leaving the other financial assets classes exposed to the global free markets. The true DSE guaranties demand and adjust the supply to fit the real demand hence no deflationary death spiral is ever possible, and if value-based [not debt based] monetary system is imposed, no inflationary pressures may ever develop.”

  18. JerryDenim

    “The non-transparent derivatives market is now estimated to total US$707 trillion, or significantly higher than the US$548 billion in 2008.”

    Wow! Is this figure real? Not that 548 billion is small sum but I thought the derivative market in pre-crash ’08 was in the neighborhood of 8 trillion? It’s now 707 trillion? That’s nearly a hundred-fold increase in 9 years.

    Anyone knowledgeable enough on the world derivative market to comment?

    1. cnchal

      $548 trillion – the billion is likely a transcription mistake.

      Note the fatuous accuracy, down to the trillion where in the next paragraph is this.

      >As one analyst puts it, “The market has grown so unfathomably vast, the global economy is at risk of massive damage should even a small percentage of contracts go sour. Its size and potential influence are difficult just to comprehend, let alone assess.”

      Basically, no one knows. It could be over a quadrillion (1000 X 1 trillion) or a 1 followed by 15 zeros.

      To give these figures a faint wisp of reality, I like using Nimitz class aircraft carriers as coins of the realm.

      $707 trillion would buy 153,420 of them at their original cost of $4.6 billion each, and were they placed end to end would stretch 31,707 miles.

      Bernie Sanders: The business of Wall Street is fraud and greed.

      1. JerryDenim

        So you’re saying Uncle Sam should be able to backstop it all in the next crisis then??

        Just kidding! Thanks for the visual aid.

  19. S M Tenneshaw

    It’s not that the .01% don’t know better, it’s that, thanks to automation, they think they won’t need us anymore. They’re murdering all of us.

    1. Gman

      Oh they need us, and they need us in enough numbers to feed and fulfil demand.

      Ideally compliant, acquisitive, and fully occupied, but not necessarily fighting fit, nor fully aware or informed.

      What we erroneously still insist on calling capitalism, increasingly resembles a production line where more and more humanity in ‘advanced nations’ is slowly but surely being quantified and commodified as it sees the price of its potential labour systematically devalued.

      A necessary evil, yet by virtue of sheer numbers and ability to reproduce effectively, an expendable resource.

      The economic system we have allowed and are still allowing to develop under our very noses proceeds in baby steps so as not to spook its prey, aided by a media that simultaneously acts as the perfect sounding board for its perpetrators as well as an increasingly sophisticated, well honed source of distraction…..

      ……or maybe they’re just marking time until they can teach robots to consume and pay for the privilege?


  20. Gman

    The truly dismal ‘science’ indeed.

    Trouble is, it wasn’t economics as such that got us here, it was politics, and only politics can get us out of it. A few more newts’ eyes or frogs’ toes ain’t gonna amount to a hill o’ beans here, I’m afraid.

    Economics is nearly always given too much ‘credit’ and credibility for the circumstances we find ourselves in and serves to mask this enduring man made deliberately engineered and sustained iniquity with an air of scientific inevitability and respectability it not only shouldn’t be given, but also one that plays beautifully into the hands of those that caused it and continue to benefit.

    ‘Dismal’, I’ll buy, but ‘science’, most certainly not.

  21. Sound of the Suburbs

    The whole globalisation project has two major problems that lie at its heart and they are gradually tearing it apart.

    1) Flawed assumption on money and debt that led to 2008
    2) Bad economics, neoclassical economics, that the whole project runs on and was used to design the Euro.

    I realised something was seriously wrong in 2008 and looked into it and had to get right down to the most fundamental of all fundamentals to find the problem, money and debt.

    After doing it the hard way, I found others that had also came to the same conclusions. They write books, do interviews and lecture round the world trying to tell people what is going on but no one takes any notice.

    Twelve people were officially recognised by Bezemer in 2009 as having seen 2008 coming, announcing it publicly beforehand and having good reasoning behind their predictions.

    They all saw the problem as being excessive debt with debt being used to inflate asset prices (US housing).

    They all think you can’t use debt to solve a debt problem.

    They all think that as we have used debt to solve a debt problem a bigger crash is coming in the future.

    They write books like “De-bunking Economics” and “J is for Junk Economics” detailing the problems of the economics being used to run the global economy and that was used to design the Euro.

    Richard Koo’s ideas were actually taken on board by Ben Bernanke who made sure the US didn’t go over the fiscal cliff with austerity. The rest of the West ignores him and harsh austerity has its predicted effect in Greece and the Club-Med nations.

    Professor Werner from Southampton University is an expert on money and coined the phrase “Quantative Easing”. He is coming to conclusion, but doesn’t have the concrete evidence, that this bad economics and ignorance of money are quite deliberate and they are gradually destroying everything and will continue to do so until sound ideas come into play. Current economics allow desirable conclusions to be incorporated by working down from the conclusion to find the necessary assumptions to make that conclusion valid.

    Current theories of money and economics are yielding short term rewards for certain vested interests but in the long term they can only destroy things.

    It is the mistaken beliefs about debt that have allowed everything to run so far and debt has been used to paper over all the cracks, this comes at a tremendous cost to the future as this is where this money has been borrowed from.

    Collapsing asset prices also destroy money on bank balance sheets, the cause of 2008. This is the problem with borrowing to fund speculation, in housing and all assets. Housing booms proliferate nearly everywhere.

    Current mainstream economic and mainstream monetary theory have no mechanisms whereby money is created or destroyed and 2008 wasn’t sufficient for them to look again at their theory.

    We are on the road to ruin.

    Alternative and I would say much more accurate realities:

    1) Michael Hudson “Killing the Host”, “J is for Junk Economics”
    The knowledge of economic history and the classical economists that has been lost and the problems this is causing. Ancient Sumer had more enlightened views on debt than we have today.

    2) Steve Keen “De-bunking Economics”
    His work is based on that of Hyman Minsky and looks into the effects of private debt on the economy and the inflation of asset bubbles with debt.

    3) Richard Werner ”Where does money come from?”
    The only book generally available that tells the truth about money, I don’t think there are any other modern books that do and certainly not in economics textbooks

    4) Richard Koo’s study on the Great Depressions and Japan after 1989 showing the only way out of debt deflation/balance sheet recessions.

    Milton Freidman was half-right with his monetarism, a steadily rising money supply does give a healthy economy, but this is not controlled by Central Banks. The private banks lend and the Central Banks create the reserves. This is why monetarism didn’t work as the Central Banks are not in direct control.

    Milton Freidman understood the effect of the money supply, but didn’t really know how money worked.
    Monetarism was abandoned and sometime later we saw this:

    Let’s look at the US money supply leading up to 2008:

    M3 is going vertical before 2008.

    Money = debt and a credit bubble is blowing up.

    2008 bang.

    Steve Keen understood and saw it coming in 2005.

    Look at that tiny graph ………

    Everything is reflected in the money supply.

    The money supply is flat in the recession of the early 1990s.

    Then it really starts to take off as the boom gets going which rapidly morphs into the US housing boom, courtesy of Alan Greenspan’s loose monetary policy.

    When M3 gets closer to the vertical, the black swan is coming and you have a credit bubble on your hands (money = debt).

    In debt deflation/balance sheet recessions the private sector isn’t borrowing and the money supply is going down, this is the nightmare scenario Central Bankers fear.

    As Central Bankers are the lenders of the last resort, Governments are the borrowers of last resort and the only player capable of keeping the money supply stable. This is why austerity makes things worse.

    The truth is out there, finding it is another matter.

    1. Sound of the Suburbs

      Professor Werner moving from reality to fantasy:

      “Classical and neo-classical economics, as dominant today, has used the deductive methodology: Untested axioms and unrealistic assumptions are the basis for the formulation of theoretical dream worlds that are used to present particular ‘results’. As discussed in Werner (2005), this methodology is particularly suited to deriving and justifying preconceived ideas and conclusions, through a process of working backwards from the desired ‘conclusions’, to establish the kind of model that can deliver them, and then formulating the kind of framework that could justify this model by choosing suitable assumptions and ‘axioms’. In other words, the deductive methodology is uniquely suited for manipulation by being based on axioms and assumptions that can be picked at will in order to obtain pre-determined desired outcomes and justify favoured policy recommendations. It can be said that the deductive methodology is useful for producing arguments that may give a scientific appearance, but are merely presenting a pre-determined opinion.”

      “Progress in economics and finance research would require researchers to build on the correct insights derived by economists at least since the 19th century (such as Macleod, 1856). The overview of the literature on how banks function, in this paper and in Werner (2014b), has revealed that economics and finance as research disciplines have on this topic failed to progress in the 20th century. The movement from the accurate credit creation theory to the misleading, inconsistent and incorrect fractional reserve theory to today’s dominant, yet wholly implausible and blatantly wrong financial intermediation theory indicates that economists and finance researchers have not progressed, but instead regressed throughout the past century. That was already Schumpeter’s (1954) assessment, and things have since further moved away from the credit creation theory.”

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