Michael Hudson: Review of Steve Keen’s “Can We Avoid Another Financial Crisis?”

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By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City, and a research associate at the Levy Economics Institute of Bard College. His latest book is J is For Junk Economics

At first glance this book seems too small-sized at 147 pages. But like a well-made atom-bomb, it is compactly designed for maximum reverberation to blow up its intended target.

Explaining why today’s debt residue has turned the United States, Britain and southern Europe into zombie economies, Steve Keen shows how ignoring debt the blind spot of neoliberal economics – basically the old neoclassical just-pretend view of the world. Its glib mathiness is a gloss for its unscientific “don’t worry about debt” message. Blame for today’s U.S., British and southern European inability to achieve economic recovery thus rests on the economic mainstream and its refusal to recognize that debt matters.

Mainstream models are unable to forecast or explain a depression. That is because depressions are essentially financial in character. The business cycle itself is a financial cycle – that is, a cycle of the buildup and collapse of debt.

Keen’s “Minsky” model traces this to what he has called “endogenous money creation,” that is, bank credit mainly to buyers of real estate, companies and other assets. He recently suggested a more catchy moniker: “Bank Originated Money and Debt” (BOMD). That seems easier to remember.

The concept is more accessible than the dry academic terminology usually coined. It is simple enough to show that the mathematics of compound interest lead the volume of debt to exceed the rate of GDP growth, thereby diverting more and more income to the financial sector as debt service. Keen traces this view back to Irving Fisher’s famous 1933 article on debt deflation – the residue from unpaid debt. Such payments to creditors leave less available to spend on goods and services.

In explaining the mathematical dynamics underlying his “Minsky” model, Keen links financial dynamics to employment. If private debt grows faster than GDP, the debt/GDP ratio will rise. This stifles markets, and hence employment. Wages fall as a share of GDP.

This is precisely what is happening. But mainstream models ignore the overgrowth of debt, as if the economy operates on a barter basis. Keen calls this “the barter illusion,” and reviews his wonderful exchange with Paul Krugman (who plays the role of an intellectual Bambi to Keen’s Godzilla), who insists that banks do not create credit but merely recycle savings – as if they are savings banks, not commercial banks. It is the old logic that debt doesn’t matter because “we” owe the debt to “ourselves.”

The “We” are the 99%, the “ourselves” are the 1%. Krugman calls them “patient” savers vs “impatient” borrowers, blaming the malstructured economy on personal psychology of indebted victims having to work for a living and spend their working lives paying off the debt needed to obtain debt-leveraged homes of their own, debt-leveraged education and other basic living costs.

By being so compact, this book is able to concentrate attention on the easy-to-understand mathematical principles that underlie the “junk economics” mainstream. Keen explains why, mathematically, the Great Moderation leading up to the 2008 crash was not an anomaly, but is inherent in a basic principle: Economies can prolong the debt-financed boom and delay a crash simply by providing more and more credit, Australia-style. The effect is to make the ensuing crash worse, more long-lasting and more difficult to extricate. For this, he blames mainly Margaret Thatcher and Alan Greenspan as, in effect, bank lobbyists. But behind them is the whole edifice of neoliberal economic brainwashing.

Keen attacks this “neoclassical” methodology by pointing that the logical fallacy of trying to explain society by looking only at “the individual.” That approach and its related “series of plausible but false propositions” blinds economics graduates from seeing the obvious. Their discipline is the product of ideological desire not to blame banks or creditors, wrapped in a libertarian antagonism toward government’s role as economic regulator, money creator, and financer of basic infrastructure.

Keen’s exposition undercuts the most basic and fundamental assumptions of neoclassical (that is, anti-government, anti-socialist) economics by showing that instead of personifying economic classes as “individuals” (Krugman’s “prudent” individuals with their inherited fortunes and insider dealings vs. spendthrift individuals too economically squeezed to afford to buy houses free of mortgage debt) it is easier to start with basic economic categories – creditors, wage earners, employers, governments running deficits (to provide the economy with money) or surpluses (to suck out money and force reliance on commercial banks).

His Figure 16 shows how stable UK private debt/GDP was for a century, until Margaret Thatcher deranged the economy. Debt soared, and mainstream economists applauded the boom. (He suggests calling this new wave of neoliberal policy “deform,” in contrast to “reform.” We certainly need a new vocabulary to counter the soporific euphemisms used by the fake economic news media.) Privatization of Council Housing and basic infrastructure forced the population deeply into debt to afford their basic needs. The financial City of London ended up the big winners, while industry or labor have suffered a debt squeeze.

Keen’s model shows that a long debt buildup can give the appearance of prosperity, until the crash comes. But when it comes, voters blame the party in power, not the earlier promoters of nationwide debt peonage. Along with Thatcher, Keen places the blame the pied piper of Wall Street deregulation Alan Greenspan, whom he calls “a maestro of delusion, not of insight.” He also cites Larry Summers as an example of the learned ignorance beclouding economic discussion – which of course is just why the Clintons and Obama were told by their Donor Class to anoint him.

This book enables the non-mathematician to pierce the shell of mathiness in which today’s economic mainstream wraps its lobbying effort for the big banks and their product, debt. The needed escape from the debt deflation they have caused is a debt writedown.

The problem is that the public is brainwashed to imagine that it is the banks that need saving, not the indebted economy. Keen proposes a “Modern Debt Jubilee” that is essentially a swap of equity for debt. The intellectual pedigree for this policy to keep debt within the ability to pay was laid two centuries ago by Saint-Simon in France. His solution was for banks to take an equity position in their clients, so that payments to backers could rise or fall in keeping with the fortunes of the enterprise. Keen urges that this become the basis for future banking.

As a transition from todays debt stagnation, he suggests that the central banks create a lump sum to put into everyone’s account. Debtors would be required to use their gift to pay down the debt. Non-debtors would keep the transfer payment – so as not to let demagogic political opponents accuse this plan of rewarding the profligate.

If this solution is not taken, debtors will continue to lumber on under debt and tax conditions where only about a third of their nominal wages are available to spend on the goods and services that labor produces. The circular flow between producers and consumers will shrink – being siphoned off by debt service and government taxes to bail out bankers instead of their victims.

This should be what today’s politics is all about. It should be the politics of the future. But that requires an Economics of the Future – that is, Reality Economics.

Toward this end, Keen’s pamphlet should be basic reading for placing debt at the center of today’s political debate and replacing mainstream “barter” economics with a more reality-based discipline.

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  1. Ruben

    “Keen’s exposition undercuts the most basic and fundamental assumptions of neoclassical (…) economics by showing that instead of personifying economic classes as “individuals” (…) it is easier to start with basic economic categories – creditors, wage earners, employers, governments running deficits (…) or surpluses (…).”

    This is a key insight to the scientific analysis of economies. Studying individuals is all good but it is incomplete as a scientific program. In the study of populations (and economies are population processes), the modeling of the relations among collective structures is essential, as shown by the progress of physics and biology.

  2. Chauncey Gardiner

    Re “Bank Originated Money and Debt” (BOMD) and Keen;s observations about Greenspan’s view toward private sector debt:

    Watched a recent interview of Alan Greenspan on Bloomberg. Greenspan’s opinion is that the US government is on the road to exploding deficits due to high entitlements spending, and high interest rates will result which will in turn lead to economic slowdown. Greenspan’s suggested solution is to cut entitlements, gut regulation (particularly of Wall Street under Dodd-Frank), use “Public-Private Partnerships” to fund infrastructure improvements “to get the debt out of the federal government”, and to continue to ramp stock and real estate prices (which he believes creates both corporate capital investment and consumer spending).

    Remarkable. It’s as though Q1 2017 GDP growth isn’t forecast at 0.2 percent, but 6%; that financial asset and residential real estate prices aren’t at or near all-time highs; and that the causes underlying the bubbles and the collapse of the financial system in 2008 never happened. Current levels of private sector debt and the fact that the federal government can and does create money by spending it into existence remain unmentioned. “They have learned nothing and forgotten nothing,” indeed.


    1. fajensen

      The realisation that “The Maestro” Alan Greenspan is in fact a moron spouting platitudes and, terrifyingly, just one of many similar morons placed in charge of “god-like-powered” mechanisms, capable of remodelling the planet according to the morons desires, has been one of the scarier experiences of growing up!

      1. J Gamer

        Hmmm….Gut regulations and promote the privitization of infrastructure. These solutions clearly promote the interests of the rentier class. Infrastructure might be the last and largest bit of untapped capital remaining in this country. Greenspan’s no idiot. He’s just doing the bidding of his masters.

      2. sid_finster

        Any wino can look like a financial genius, as long as the said wino can borrow and refinance.

      3. John k

        Can’t tell if these sycophants are morons. Certainly well paid bank servants. Often well paid servants know more than they let on.

        1. edr

          John k
          May 3, 2017 at 1:15 pm

          “Can’t tell if these sycophants are morons. Certainly well paid bank servants. Often well paid servants know more than they let on.”

          Be sure. The sycophants aren’t morons. They are mouthpieces for their benefactors in the private sector, their financial futures were built on their ability to create believable rationalizations for the interests of Wall Street Banks and Politicians (that are also bought and paid for by the bankers, military manufacturer’s etc, ..)

          That’s why there is no convincing them.

          The politicians are already convinced that they must believe whatever it is the donor class is pushing and that they must contribute developing believable narratives for their donors.

          Who is worth convincing? The public, professionals, college students, small business owners…,,,

    2. R Foreman

      There wouldn’t be a large need for welfare if so much spending weren’t being diverted to financial payments.

    3. Adamski

      Kween covered this in a blog post, Greenspan previously saying house and share prices should go up to create spending from a wealth effect. But apparently there is only evidence for the former, not the latter. A “sleight of mouth” as Keen put it.

    4. Kurtismayfield

      The man is 91 years old. At this point we really need to be taking any advice he gives with a grain of salt. Especially if it just is the same olde stuff he has been spouting for his entire life, and that advice has been shown to be flawed. Remember if you are a hammer all you see is nails.

      1. JustAnObserver

        91 & he still goes to sleep every night with a portrait of Ayn Rand under his pillow.

  3. sd

    News in Iceland today, real estate prices have increased 19% since last year. Needless to say, income has not.

    Canary in the coal mine?

    1. fajensen

      Njaeh, Give it some time to mature. The time to “short Iceland” is when Icelandic entrepreneurs are buying so-so businesses in Sweden and Denmark. This happens somewhat after all the airline in-flight magazines are stuffed with stories on how exceptional Iceland is.

    2. michael hudson

      This is a result of Iceland’s capital controls. Keeping bank and pension fund money inIceland leads it to be lent out for property.
      The press isn’t explaining that Iceland’s banks have so much money that they can’t get out without crashing the kroner that the only result is to inflate domestic asset prices.

      1. Tom_Doak

        How can they have “so much money” now? Is it because there’s also been a lot of hot money from the outside flowing in?

      2. zapster

        What should they do to correct it? Why aren’t they investing it in workers?

      3. sid_finster

        You see a similar phenomenon in many third world countries. Noone trusts banks or the stock markets, so spare cash gets parked in real estate, most of the time not rented.

      4. /L

        Couldn’t the Icelandic Central Bank drain out excessive Icelandic kronor from the system? From where did the Banks get this excessive liquidity?

      5. psv

        There are some other specific local factors at play, as detailed in a recent article in Icelandic web publication Kjarninn (article in Icelandic).

        First is a shortage of apartments being built since 2009, especially in the Reykjavík area, and given that the age cohort born in the early 90s is comparatively large. A second reason is the emergence of companies buying apartments en masse to service the rental market, which until recently has been relatively informal. According to the article, one such company named Gamma started buying apartments in bulk in downtown Reykjavík around 2012, which has had an upward pressure on prices.

        A third factor is obvious to anyone living here, the huge increase of tourists in the past few years. While this has brought currency to the country, the numbers have increased from half a million a few years ago, to over 2 million currently, with a projection of 2.3 million this year. These people need a roof over their head. According to an Arion Bank report in January, about 3200 apartments are being rented out by AirBnB or similar services. The number of apartments used exclusively by AirBnB rose from around 300 in 2015 to 809 last year, according to an Íslandsbanki report, and that 500-apartment increase more than absorbed the 399 new apartments coming on the market that year.

        Finally the article mentions government actions such as the “correction” to indexed loans after the economic crash, which benefited the wealthiest homeowners disproportionately, according to a Ministry of Finance report published in January this year.

        So it’s a bit of a mess all around, and very hard for renters currently, and people looking to buy their first apartment. These arguments above seem to suggest that continuing for at least the next year or two.

  4. cat's paw

    Uneducated person that I am, I’ve not yet been able to grasp how something seemingly so basic and fundamental cannot be agreed upon. To wit: the exchange between Keen and Krugman in which one says banks create credit and the other says bank recycle savings. Are we or are we not referring to empirical phenomena? Can it not be measured, tracked, observed? Are there not 100’s, nay 1000’s, of highly informed individuals who partake directly or indirectly in this process we might interview to help determine which is the case? Is the phenomena of credit/debt relationships so mysterious and spooky that it is actually some kind of human-created wave/particle paradox? In all seriousness, wtf? Please help.

    When a Krugman or, god forbid, a real first-rate intellectual clown like Greenspan, is just surfing the waves of neoclassical discourse I instinctively feel the idiocy well before my senses register even a vague impression–kinda like animals clearing out and heading for the hills days before the eruption or tsunami hits–but for the life of me….how can the above still be in actual dispute? Surely there is at least one accountant out there who knows the answer.

    1. Ruben

      Actually it is not easy to determine which way is it, bank credit creation or bank recycling savings, because of so many funds transfers carried out every minute on any bank. However, there was an empirical test carried out in Germany by carefully examining the actual internal accounting during a real bank loan to the researcher carrying out the study. The published paper is:

      Werner, R.A.. 2014. Can banks individually create money out of nothing? — The theories and the empirical evidence. International Review of Financial Analysis 36, 1–19.

      This a mainstream peer-reviewed journal (Elsevier).

      The conclusion is pretty much unquestionable and unambiguous. Here is the Abstract:

      This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical
      study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish
      whether in the process of making the loan available to the borrower, the bank transfers these funds from other
      accounts within or outside the bank, or whether they are newly created. This study establishes for the first
      time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy
      dust’ produced by the banks individually, “out of thin air”.

      1. mcar2015

        Very interesting – I’ve never before come across such an empirical demonstration.

        Additionally, the Bank of England (who ought to know), publish a very concise and well written account of how money is created (PDF is available on their website), which unequivocally states that banks create money out of thin air (i.e. loans create deposits, not the other way round). That such a revered “expert” as Krugman does not seem to know this is truly staggering.

        1. Disturbed Voter

          It is difficult speaking truth to power. Impossible if your job is cooking the books. Crooked accounting goes back before the invention of money, to Babylon and receipts on clay tablets. In Babylon you could create requisitions to the temple grain supply, almost out of thin air, if you could read and write. Fortunately for data quality, few people could … the small population of scribes were relatively easy to vett. The 10% works for the 1% … provided that they stay honest.

          The rest, the 90%, get subsistence courtesy of the gods. Babylon had labor and debt peonage. The “shekels of silver” were mostly notional, not actual transactions, just a convenient accounting unit, created on a magic clay tablet instead of a magic spreadsheet. And people then and now, live by mythology and magical thinking. We are missing the holiday temple tarts however ;-)

          1. Mel

            And the Jubilee, which Hudson has documented, when debts to the temple were written off. Jubilee was an acknowledgement that the wages set by the temple had been set too low, and the necessary correction.

            1. OpenThePodBayDoorsHAL

              We ignore the wisdom of the deep past (like Jubilee) because we are oh-so-modern and advanced, but the basic mechanisms they encountered are identical to ours: debt; issuers; borrowers; goods; services; wages; interest rates. The ancients arrived at practical solutions like Jubilee from repeated, painful, analogous experience, not just because they were “ancient”.
              Now if we could also inherit the wisdom from the deep past about money systems where people at the top can materialize more “money” for themselves anytime they like we’d be getting somewhere.

        2. Ruben

          The Bank of England may have stated that in one of its papers but when it’s time to vote with its feet the Bank of England seems to endorse the theory that banks are mere intermediaries between savers and borrowers (the financial intermediation theory). See the Bank of England forecasting tool document:


          The paper by Werner is very well written and has an excellent review of the literature, I recommend it highly.

          1. zapster

            You can see that larded all throughout the Fed’s white paper collections. They never quite copped to the distinctions between gold standard and fiat. I think it may be filtering in now, but their theorists and operations don’t appear to talk to each other much.

          2. BJM

            yes the Werner paper is very good and I recommend to anyone who is struggling with this issue.

        3. JustAnObserver

          “It is difficult for an academic to understand something when their position depends on ignoring the evidence” – With apologies to the shade of Sinclair Lewis for porting the original to a new context.

      2. todde

        I will agree except for the out of thin air part.

        I never saw a bank create money out of thin air to buy a building for its own use.

        Banks create money out of other people’s earnings, either past or future earnings.

        1. Tom_Doak

          They just have to pass the thin air through a bunch of suckers [us] as filters first.

        2. Tom_Doak

          BTW, I realized how easily they create money from electrons a few years ago, when someone managed to pull off a succession of fraudulent wire transfers from my company’s account. [This in spite of the fact that our bank’s rules required us to make the transfers in person, and no one had done so.]

          We discovered the fraud after 3 or 4 days of successive transfers to an overseas account, well into six figures. Clearly they couldn’t claw it all back by that time. But once they realized that we were not at fault, they credited all the funds back to our account.

          Do you think they did that out of others’ deposits? Or their own profits? I believe it was just electrons, and it made me realize it’s all electrons to them now.

        3. /L

          I believe it’s something like this.
          Money for nothing, not new.
          But of course, during the day money float in and out of the bank. And at the end of the day the bank must balance its accounting. If more have floated out than in it must borrow on the interbank market or slightly more expensive at the Central Banks discount window where there always is money. CB accommodate the payment system but force the banks with a penalty rate to borrow at the interbank market. So, when all banks create “deposit” money there will be more money.

          Thatcher/British example from the 80s is common neoliberal deregulation. We can see on all kind of charts how debt/credits have grown immensely since mid 80s. All balanced on the debit column. Where did it come from? Savings?
          We hear now and then from e.g. Oxfam how a few own more than most others on the earth. It’s not like Scrooge McDuck’s Money bin, its possessions on markets.
          Let’s say an area with 100 similar houses at a “real” value of one million, the the bank extends credits so one or two houses is sold for 1.5 million. Suddenly the aggregate wealth in the neighborhood have increased from 100 to 150 million. That can be used as collateral for lending. So also on financial markets. Credits creates “wealth”.
          It’s “wealth” in this Ponzi-system Oxfam refers to when they talk about how much some own compare to the rest. It’s what some leftist think we can tap into to tax to benefit the poor. But why should we need a Ponzi-scheme to maximize the utilization of real resources?

          1. Michael G

            I agree that banks create money out of thin air, though the fig leaf is that they lend against collateral.
            The first key point is that every time a bank makes a loan, say to buy a house, it alters demand but not supply, and increases the apparent value of the collateral. It can claim that it is acting responsibly and that there are assets that cover the value of the loan, but part of that collateral has been created out of thin air by the loan itself.
            The question that puzzled me for a long time was where did the money we lost in 2008 go to? Was someone sitting with all the the money that the rest of us lost? The answer I slowly came to, was that making loans creates imaginary value in assets, and that it is the imaginary value that can disappear into thin air.

        4. gordon

          The way I’ve made sense of this is that money is a promise; the stuff that we call “money” is just a way of keeping track of economic promises. (And what are promises made of? Thin air? High hopes and good intentions?) Bank promises are (generally) pretty good, you could definitely buy a building with a bank promise, I’ve done it several times, promising in turn to pay the bank some money over time…

          There’s real money there (that is, government money aka reserves), but the key is it rarely leaves the banking system (some circulates in and out of the banking system as paper currency, but not much), it just gets moved from one account to another, or possibly from one bank to another. And the central bank (Fed, in our case) always makes sure that the banking system can get all the reserves it wants at the Fed’s target rate.

          So the bottom line, the banking system can create deposits at any amount, as long as they can find creditworthy borrowers, and the Fed will accommodate as required.

          Two problems arise, as Keen notes: one, banks eventually lend to people who will not be able to keep their promise to pay the bank. This is inevitable because of the other problem Keen notes; compound interest means that more and more money is siphoned off as interest payments. When consumption falls enough because people are passing too much of their income as interest payments to the banks, then would-be producers begin defaulting on their loans.

        5. gordon

          “Banks create money out of other people’s earnings, either past or future earnings.”

          In an uncertain world, how do you distinguish between future earnings and thin air?

        1. Mel

          Carlo Ponzi knew, or should have known, or could have known, that he was never going to make enough by arbitraging International Postal Reply Coupons to pay off his investors. Whereas modern banks issuing loans were able, up to now, to count on most of their loans being paid back. If we’re going to keep seeing things like the ..2007 Mortgage-Backed Securities feeding frenzy, then it won’t be much different from a … no, I’m not going to go with Ponzi scheme. In Ponzi’s scheme early investors got paid by later investors, and the scheme kept its momentum. In Ponzi’s time, the money supply was vaguely constrained by the supply of gold. Nowadays payment can come from nobody, unless it doesn’t come at all.

        2. Wisdom Seeker

          Two differences:

          1) The main difference is that the Fiat Money Ponzi is too complicated for most people to figure out, especially if the central bank keeps the growth rate in the single digits. So the scheme can go on for decades before blowing up.

          2) The other main difference is that in Fiat Money Ponzi, the perps are lenders rather than borrowers, and the lending is usually tied to a claim on collateral. (In a traditional Ponzi, the perp is a borrower rather than a lender.) In Fiat Ponzi, when the credit system blows up, and people can’t repay their loans, the banks end up owning all the wealth. So the banks can’t lose – unless the pitchforks come out.

          So I’d call a fiat money system a Reverse Ponzi. In a forward Ponzi, the perp borrows from the victims and then never pays most of them back. In Fiat Money, the perps lend to the victims, and then seize their assets when the Ponzi breaks down and the victims can’t pay them back.

          BTW, I strongly support the comments above that anyone who wants a clean science of economics needs to start by fixing the language. Current finance-speak is freighted with pro-lender terminology.

    2. jerry

      Banks create credit. Deposits do not get “lent out”. Banks keep a very low level of liquid cash (electronic) reserves on hand for anticipated withdrawals (reserve ratio), the rest can be used for whatever purposes they want.

      When they make the loan, the appropriate account is simply credited electronically or whatever method was used, then at the end of the day the bank borrows any excess reserves required from the Fed to meet their reserve requirement.

      This is why the mortgage crisis made it look like the economy was growing like crazy, bank credit was used to inflate asset prices. But of course there is a liability for every asset. In the case of government deficit spending, this liability is sustainable. In the private sectors case, not so – as we saw.

    3. BJM

      @cat’s paw,
      yes it is good question as why something so basic is a source of confusion and uncertainty. After reading about this for years and following it closely I have come to the conclusion that there is a degree of intentional obfuscation involved. If you go back a look at the history of money and banking, private interests cut themselves in on the process of money creation a few hundred years ago. Banking is an industry, a very powerful one, and like any industry it has its interests and agenda. It still begs the question as why many economists are confused on the issue. As Ruben points out, the fact that deposits are tied into a sophisticated payment/transfer system confuses the issue of money creation for many people. There are a number of conspiracy theories involving banking and the real control over the system. I choose not to focus on those even though there is a good deal of circumstantial evidence to support those ideas. Whether by design or incompetence, there is something rotten with the system.

      In any event deposits are conjured from nothing when loans are made. The story that banks take in deposits from savers and lend them out to borrowers, implying there is only so much money in the system, is utter nonsense. Just sit down with a couple of t-accounts and try and figure out how a bank could lend out a deposit; it’s impossible.

      Keen’s book sounds excellent. For those wanting a shorter (50 pages) and more polemical/entertaining version of this topic, I recommend the following article on the website Medium.


      1. cat's paw

        Firstly, thanks Ruben for the reference. I’ll check it out. I found this line of the abstract droll. “Surprisingly…until now no empirical study had tested the theories.” Should read: “Stupefyingly….”

        Are economists really this incurious? Involuntarily emitting Econ 101 nonsense when an undergrad or journalist presses the correct button is one thing; it’s certainly contemptible enough, serving a rather pure and transparent ideological function akin to members of a priestly caste promulgating known falsehoods among the uninitiated so as to preserve social order and stratification. But on rather basic empirical matters (let’s go ahead and stipulate all necessary and sufficient complexity involved in the real world happenings associated with credit creation vs. recycled savings) which can be tested or at least investigated, but studiously are not….what can one say? Gross malpractice and negligence are benign understatements. Fraud seems a better referent. Now, someone might argue that the question is unimportant and would only reveal a distinction without a difference. If so, fine, but I haven’t yet come across such an argument, though I’m happy to listen.

        /L notes a real world crux of the matter in an above comment. Presently, credit creation, fairy sprinkles, 1’s and 0’s, whatever you want to call it, inflates financial assets and “wealth” which allows those who hold and control such imaginary playthings to hold and control in concentrative fashion actually existing playthings–real estate, missile launchers, jewelry, entitlement programs, grain, and so on, insofar as the rubes go into greater and greater debt to pay for said playthings….In a situation where a debt of the many owed to the few grows inexorably the outcome is already foretold. See, Nietzsche, F. Genealogy of Morals. Once the debt and its inevitable corollaries (guilt, bad conscience, bondage, enslavement) becomes too much to bear a sacrifice becomes necessary. 2000 years ago Jesus of Nazareth, aka Son of God, was said sacrifice. Presently, that sacrifice may well be the exquisite dream of all capital and credit, the global market. What else can be killed that has the necessary symbolic and concrete value to balance out such massive and pervasive debt?

        It seems the dream in the 90’s and early 2000’s was to spread enough of the creditors and credit creating capacity among the total population to smooth over the worst social effects of a world economy built on debt peonage. Have just enough buy-in from across the classes below so that creditor/debtor relationships were deeply embedded and interwoven even among the poor, working, and middle classes. But I think that dreamed died, oh, around 07/08. There will be no more dreams of that kind. Ever since, and of course well before, there are only sacrifices to be made. As such, signs are pointing toward a much, much larger sacrifice looming on the horizon.

      2. Ruben

        Thank you B.J., the article has an interesting start. I for one will take with me for a read over the weekend.

        1. B.J.M.

          It has actually been read by a real life central banker, who will go unnamed in respect for his privacy and willingness to speak candidly with me about his thoughts. All I can say is that he told me he thoroughly enjoyed it and that there is nothing in it he disagrees with. That is pretty stunning once you know what in is in the essay, also a bit scary.

          You strike me as being very well read on this subject with a good understanding of money creation so you may not learn to much from the essay, but I still think you will find it insightful and entertaining to read.

    4. Yves Smith Post author

      As we’ve written many times, Krugman is wrong. He’s repeating what is called the “loanable funds theory” which was partly debunked by Keynes in the 1930s and finally dispatched by Kaldor in the 1950s. There is also a lot of empirical work that clearly shows that loans precede deposits, which would be impossible if banks were actually lending out savings.

      The Bank of England paper linked to above is very good. Greenspan also let slip once that the Fed is unconstrained by savings, and former Treasury official Frank Newman has also made a pretty straightforward statements about lending creating money. But the Fed is full of Chicago School of Economics economists who believe in outdated monetary theories.

  5. AbateMagicThinking but Not money

    Am I wrong in saying that Credit equals Debt – equals Belief (Plus Time), but NOT Barter?

    Most mainstream economists have never had to barter anything in their lives, but It comes as a surprise to learn that any thinking person would treat any developed economy as if it were an equivalent to barter.

    However, it comes as no surpise that something is sold to the public as “x” but on close examination, the only conclusion can be that it is, and can only be “y”.

  6. H. Alexander Ivey

    Thanks for the posting on this review of Keene’s new book. It’s good to hear that he has published a new work, I look forward to purchasing a copy.

    I couldn’t help but notice that Keene is no longer using Australia as an example of bad economics in play. After relocating to the UK (his Australian university department was shut down), he now is showing how poor the UK and the US economist’s policies are. Guess the Aussies boys are breathing a sigh of relief that he isn’t focusing on their little outback.

  7. Jim Haygood

    [Keen] suggests that the central banks create a lump sum to put into everyone’s account. Debtors would be required to use their gift to pay down the debt.

    Substituting gov debt for private debt: that’s what QE was all about. How’s that workin’ out for us?

    1. ger

      Exactly, the Fed gave banks free money (thin air) to loan out at usury rates that lead to the current credit “bubble”. The borrowers are expected to repay it in real cash from their meager wages instead of thin air. The banks repay the Fed with thin air and keep the rest to pay fat bonuses and build more bank buildings least the public should be inconvenienced in driving across town to borrow more thin air.

      1. Jim Haygood

        Michael Hudson’s careful distinction that “if private debt grows faster than GDP, the debt/GDP ratio will rise” sounds like an MMT tic. Most commentators recognize that ALL debt matters. For instance, this is from Hoisington Management’s First Quarter 2017 report:

        Total domestic nonfinancial debt, excluding … unfunded pension liabilities, surged to a record 254.8% of GDP in 2016, 5.6% greater than in 2009 when Lehman Brothers failed.

        Total debt, which includes domestic nonfinancial, foreign and bank debt, amounted to 372.5% of GDP in 2016 compared with 251.9% of GDP in 2006, which in turn was greater than any earlier time since 1870.

        The situation in the business sector deserves particular scrutiny. Business debt surged to a record 72.6% of GDP in 2016, for the first time eclipsing the prior peak of 70.2% in 2009.

        In other words, business debt is high in relation to the earnings available to service it. But the towering, snow-capped mountain of total debt is nigh on five times larger.

        And the excluded unfunded pension liabilities could be the real show stopper, when stocks end their gigantic rally,

        1. RabidGandhi

          I’m totally buying Comrade Haygood an “All Debt Matters” gold-plated t-shirt. That is as soon as I get my QE cheque so I can afford it.

          1. OpenThePodBayDoorsHAL

            Simply separate “money” from “credit” et voila, not every credit crisis would also automatically then be a monetary crisis too.

            Bankers gonna bank, it’s what they do. They have a product to sell (debt), of course they sell as much as they can, especially with a fool taxpayer there ready to eat the losses for them.

            Alternately we could try something called capitalism, surely you remember, that system where bad business management resulted in the bankruptcy of the business? Seems to work in lots of other businesses.

    2. Trish Flanagan

      Except it didn’t go to the private sector to pay down debt, it went to the financial sector to indemnify them against bad loans they had made to the private sector. Private debt was not written down and the fat cats got fatter. If that money had flowed into the economy through public sector spending, private debt levels would have been reduced and the financial sector stranglehold on the economy would have been reduced. The problem was that debt relief did not reach the private sector, but was used to shore up and enrich the corrupt financial sector.

    3. zapster

      They didn’t put QE in everybody’s account. They only gave it to banks, so the debt problem remains.

      1. John k

        QE just bought gov debt previously sold to private sector, lowering long term rates. People that wanted a stream of income now had cash which they used to bid up other financial assets, stocks, risky bonds, real estate, etc.
        Fed then returns gov interest payments to treasury, so no cost money. Of course this shows gov can be self funding, no need to borrow at all… banks don’t like that, unfair competition.

        1. nothing but the truth

          to prevent these new cash reserves from being lent out, bernanke got the law modified so he could pay interest on reserves to the banks.

          This was well before the crisis, so he knew what was coming for a long time, and was preparing for it.

    4. ex-PFC Chuck

      A while back Keen wrote about a model he developed and ran using his Minsky software which showed that the same level of positive effects that the trillions of $ siphoned to the TBTF banks via QE would have been achieved by if one tenth that amount of $ had been fed into the economy via households and small businesses via tax cuts, etc.. Below is a link to what appears to be the QE part of the analysis but so far I haven’t found the direct economy infusion part. At the end of the piece there are links to the Minsky input data, as well as the Minsky SW itself.

      1. Adamski

        Another interesting result from the model was that workers absorb the cost of the private debt

    5. Mel

      Government-issued currency and business debt are different in a few ways:
      * currency has no due date
      * currency, unlike business debt can’t be called by the creditor
      * in fact there’s no recourse for the creditor to be repaid at all. Currency “debt” is canceled when the government uses the law to create an opposite tax debt and allows the currency to be brought in as payment.

      It’s true that the government can do special favors for special friends, but they could do that even without monetary theory.

      1. OpenThePodBayDoorsHAL

        The government doesn’t issue currency (except perhaps the CB of Ecuador), commercial banks do (governments do print up cash in the basement but it’s something like 1% of the supply). Lincoln and JFK both tried to change that. Alas.

  8. cnchal

    The intellectual pedigree for this policy to keep debt within the ability to pay was laid two centuries ago by Saint-Simon in France. His solution was for banks to take an equity position in their clients, so that payments to backers could rise or fall in keeping with the fortunes of the enterprise. Keen urges that this become the basis for future banking.


    The biggest criminals in the world then own you lock stock and barrel, with no escape, and “it” will have to be done their way or they crush you.

    1. mle detroit

      Now that you mention it, that does sound like it would turn a bank into a Private Equity firm. Yves, what say you?

    2. Adamski

      I thought Keen had previously ruled this out when he had looked at Islamic finance and concluded it wouldn’t stop bubbles

      1. Adamski

        There’s a Youtube vid of a lecture where he covers it, I’ll try to find it and post it later.

  9. Scott Garren

    The cycle of buildup and crash of debt is not new! I highly recommend David Graeber’s “Debt, The First 5,000 Years.” It’s been going on for millennia.

  10. MisterMr

    I’ve been a fan of Keen for a while, but now I have a more nuanced opinion of his work because I think that his theory is basically an underconsumptionist theory, but he underplays the “underconsumption” part of the theory and spends a lot of time about the financial part of the theory, perhaps because of his academic interests. I think the “underconsumption” part of the story is more important.

    Here is my point: suppose that A buys a new house from B, entirely on credit. A gets in debt with the bank, and in turn the bank credits some money on B’s account.
    The the bank “created” credit, debt and spending power contemporaneously, this is the whole point of “endogenous money”.
    But the bank didn’t create the house, so this whole story implies that there was some unused productivity in the economy, and the additional spending power created by the bank activated this unused productivity.
    In other words, the bank doesn’t recycle “savings” into consumption, but rather “unused productivity” into actual productivity and consumption, while contemporaneously piling up financial assets.

    If we live in times of “underconsumption” then if the banks don’t create spending power the economy just enters into recession, so the main problem is the latent underconsumption, not the bank.

    If I understand correctly Keen’s model, it’s based on a double cycle: there is a base industrial “Goodwin cycle” that represents the cycle of “real businesses”, and in this cycle the wage share varies between some parameters (represented by a mysterious not defined function X). When the economy is booming “businesses” make a lot of money, that they have to reinvest somewhere, and if the bankis are optimist this money enters the financial cycle and there is a credit boom, but then the rate of profit falls (because of the Goodwin cycle) and the debt becomes “excessive” and there is the “debt deflation” (this is the “Minsky cycle” that is superimposed on the “Goodwin cycle”).

    But there are two problems:
    1) first of all, the whole story depends on “function X” that represents the wage share function. Many political choices since the 80s explain why the wage share fell overall over the Goodwin cycle, but then this means that the causality is the opposite: first the wage share falls, then we enter in a more “debt dependent” economy.
    If the main problem is “function X”, then we should speak of it and not of the banks.

    2) The Goodwin cycle doesn’t have underconsumption, nor disinvestiment, in it’s original formulation (that is a weird neoclassical/malthusian stuff related to population growth and not unemployment), so in Keen’s model “underconsumption” doesn’t happen, but in the downward phase of the cycle there is disinvestiment, that implies underconsumption in Keen’s model (because it uses the Kalecki equation [totali income]=Wages+[Capitalist consumption]+[net investiment], if net investiment turns negative either wages increase, capitalists start to consume more, or some stuff goes unsold, that means that realised profits are lower than capitalist consumption and creates the illusion that capitalists are overconsuming).
    The absence of underconsumption from the Goodwin model is IMHO what causes the confusion.

    1. Adamski

      I thought that underconsumption does exist in the model. The creation of new endogenous money during bank lending helps stimulate the economy in a boom which is self-sustaining for a while. In a downturn, loans are still being repaid, destroying money. But there aren’t enough new loans being made to compensate for that loss of spending power. It is not just that “banks don’t create spending power” anymore, it’s that spending power falls as existing loans are repaid.

      1. MisterMr

        I’ll try to explain my point better. Note: I read Keen’s work a pair or years ago so I might remember something wrong.

        1) Keen’s model is made of two different cycles: a “Goodwin cycle” that reflects the “real economy” and a “Minsky cycle” that reflects financial dynamics.
        2) The Minsky cycle is the main point of interest for Keen, and in the “crash phase” of the Minsky cycle there is indeed underconsumption.
        3) But the Goodwin model in its original form it doesn’t even have disinvestiment nor unemployment: it speaks of a demographic increase in the number of workers, not directly in changes in unemployment. If we change the Goodwin model in such a way that it has disinvestiment and thus underconsumption, what happens is that “finance” works by increasing consumption also in the Goodwin cycle and not just in the Minsky cycle; in short the underconsumption crises of the “changed Goodwin cycle” are papered over through debt, thus causing the “Minsky cycle”.
        4) The Goodwin cycle in Keen’s work has a “function X” (I don’t remember the actual name of this function in Keen’s work). Function X reflects all those social and institutional forces that influence the wage share apart of the Goodwin dynamics (that wages increase in booms anf fall during crises).
        If “Function X” is such that during the Goodwin cycle wages stay high, what happens is inflation or stagflation, like in the 70s. This is consistent with Minsky’s views that stagflation was what they got in the 70s instead of another great depression.
        If “Function X” is such that during the Goodwin cycle wages stay low, what happens is rising debt to income ratios for a while, low inflation, and a super bad debt/deflation + underconsumption afterwards.
        5) so we are basically speaking of:
        – social democracy-> high employment -> high wages -> high inflation -> debt level washed away by high inflation -> perhaps hyperinflation
        – lasseiz-faire -> low employment and wages -> low inflation and high leverage -> debt depression
        and in this story banks have a rather minor role, they make money because we have to continually increase debts to stave off a depression, but if we cut off banks without solving the underlying problem (high inequality leading to underconsumption) we just get the recession.

        1. cnchal

          I did a little digging into the ‘Goodwin cycle’ and found this paper which was illuminating. Thank you.


          The Goodwin cycle is based on the Lotka-Volterra predator – prey model. Lotka and Volterra discovered their findings independent from each other in the mid 1920s based on fish in the Adriatic and it’s main predator.

          In the Goodwin cycle, capital is the predator and the unemployment rate is the prey.

          From the paper, page 5:

          Goodwin presented his famous model in 1967. He tried to model economic growth and business cycles and he showed that the antagonist relationship between workers and capital owners could lead to cycles (Aquiar 2001, 2). Goodwin had a number of assumptions in his model, like (Goodwin 1965, 54):

          (7) a steady technical progress,
          (8) a steady growth in the labor force,
          (9) only two homogenous and non specific factors of production: capital and labor,
          (10) only real and net quantities,
          (11) consumption of all wages,
          (12) all profits are saved and invested.
          Furthermore, he relied on a more empirical, but somewhat disputable view:
          (13) a constant capital-output ratio,
          (14) a real wage rate that rises in the neighborhood of full employment.

          Those are a restrictive set of assumptions. Debt is also ignored.

          What this shows is that there is a cycle between capital and labor, but in my opinion, isn’t relevant to what we are going through now.

          Globalization has thrown a spanner into Goodwin’s gearbox.

    2. digi_owl

      That assumes both A and B has a use for the house beyond it being a speculative asset.

      That is far from the norm these days.

      Check out Vancouver for example, where a whole lot of money is flowing into the housing market from China.

      And in London you whole streets sitting dark because the owners are foreigners that use London housing as a stash for their money in case their governments come after them.

      Yes, in the end the reason housing is so good for this use is that in the end it has a use beyond being bounced around by speculators.

      But these days the prices being paid are far removed from whatever use anyone expect to get from the property.

      1. Adamski

        Keen suggests Property Income Limited Leverage (PILL) for that reason. The mortgage would be limited to a multiple of the annual rental value e.g. 7x. To pay more than this for a house, the buyer has to contribute more of his own cash. That is to produce a negative feedback instead of a positive one.

      2. MisterMr

        No, this just assumes that if A doesn’t buy the house B’s workers become unemployed.

        Of course it would be better if the stuff produced was also useful, but the problem is that, EVEN IN THE ABSENCE OF LEVERAGE, we can have a crisis if capitalists don’t invest enough to consume all potential productivity.

    3. TiPs

      I’m trying to digest your thoughts and having difficulty with this point: “if the banks don’t create spending power the economy just enters into recession, so the main problem is the latent underconsumption, not the bank.”

      In my Minsky view, the problem of UC is resolved in the short run by the banks creating spending power. As profit-driven entities, even if wages are stagnant or declining, banks create a deeper market by either extending maturity on loans or relaxing lending standards. Recent examples are housing and auto loans. I remember when the typical auto loan was 3 years, and now we’re getting to 7 years. We are also now seeing the effects of the auto loan “subprime bubble.”

      So, will the next recession be a result of UC, rising default rates slapping bankers in the face, or exhaustion (a slowdown in the rate of growth of debt as the customer base is depleted)?

      My point, in the Minsky view, banks and debt ARE the cause. Again, wages can be stagnant, falling, or even growing; however, regardless what the wage share does, debt grows faster than income which creates the foundation for crisis. Stagnant wages or UC simply mean the crisis will hit sooner than later…

    4. BJM

      Mister Mr.

      there is a problem with your analysis of A buying B house on credit. What if the bank looks at Mr. A and decides it will lend him 150% of what the house is really worth because A’s income stream can support the higher loan value. Why does A do this, well that is what people do in a speculative frenzy. Credit begets more credit in a virtuous self-reinforcing cycle that eventually turns into a doom loop. In this case excess credit and money is created and the bank has created a parasitic loan on the economy that inflates asset prices to its own benefit. This is what happened in the housing bubble.

  11. ex-PFC Chuck

    I put this book on reserve at my library when I first learned of it in January (I”m #1 on the list) but it still hasn’t arrived and based on this review I’m looking forward to it even more.
    I’m about a quarter of the way into another rebel economic book, but that’s far enough for me to strongly recommend it. it is Doughnut Economics: 7 Ways to Think Like a 21st Century Economist, by Kate Raworth. From the brief bio early in the book I infer that she read Economics as an undergraduate at Oxford but then went into a career working with developing countries. She has a real gift for the use of metaphor, both visual and verbal. Perhaps what she has written here could be the foundation of a progressive political-economic electoral program. A TL/DR version of what she proposes can be found at this link to her website.

    I hope Steve Keen, Michael Hudson and/or someone with similar credibility in the rebel economics community checks this book out and writes a review of it.

  12. City Denizen

    Thank you Yves et al for hosting a site where viewpoints such as Steve Keen’s may be presented and discussed. He is apparently persona non grata at conventional economics sites such as Economists View, as any mention of his work tends to get moderated down the memory hole.

  13. TiPs

    I’m torn on how to arrange Keen’s clever term and acronym: Should it be “Bank Originated Money and Debt” (BOMD) or “Debt and Bank Originated Money” (DOMB)? The formed pronounce “bombed” and the latter “da bomb.”

  14. McWatt

    The newspapers are usually very slim here. However, I sat down to breakfast the other day and was surprised by the heft of the paper. I was thinking, wow, this is a good sign, must be lots of ads.

    It was the addition of 30 pages of “Take Notices”, property being foreclosed for non-payment of taxes, that had inadvertently created the hefty size.

    Michael Hudson is a God That Walks the Planet.

  15. Oregoncharles

    ” Keen’s pamphlet should be basic reading” – only an academic would call 147 pages a “pamphlet.” “Introduction” or even “primer” would be more to the point.

    Yes, I know this is picky and beside the point, but it’s called “framing.” Somehow, these ideas have to get out of the academy. Hudson is actually fairly clear that Keen has made a good tactical decision, keeping the book short enough not to intimidate potential non-academic readers.

    In a sense, we have here a contest of popularizers, between Keen and Krugman. Unfortunately, Keen does not have the bully pulpit of a NYT column. Given the interests they represent, that’s predictable. At least Keen has NC.

  16. cr

    BOM(BE)D is the best econ term of the century. Can Keen add ARSON or other appropriate acronyms for those who run this country?

  17. TG

    “Debtors would be required to use their gift to pay down the debt. Non-debtors would keep the transfer payment – so as not to let demagogic political opponents accuse this plan of rewarding the profligate.”

    It’s obvious once you’ve pointed this out to me. Great idea! I think we should have massive debt forgiveness, but as someone who has worked very hard to avoid going into debt and to get his kids through college without saddling them with debt, even though I see the logic of it, it would still rankle me. Yes as a class workers have little choice unless they want to live in a cave and eat nuts and berries, but there is still a place for personal responsibility. This makes it palatable – even if it’s not 1-1. For example, maybe a debtor gets $1000 of debt relief and I get $500 cash, I could still live with that.

    I do also point out that another issue is government guarantees of debt. The heart of capitalism is surely that bad investments should lose money. By guaranteeing loan repayments – to college students getting marginal degrees, to corrupt politicians, etc. – we are surely boosting total debt. Let the banks be on the hook for their loans to Greece etc. and I suspect there would be a lot less debt sloshing around.

    Funny how Neoliberal economists, with their fixation on the power of the market, never address the distortions of public guarantees of private profits from making bad loans.

  18. paulmeli

    I will agree except for the out of thin air part.
    I never saw a bank create money out of thin air to buy a building for its own use.
    Banks create money out of other people’s earnings, either past or future earnings.

    Banks are allowed to create money for loans to borrowers, period. Banks can borrow just like anyone else as long as they have the collateral and the income to service the loan.

    It is mathematically impossible for deposits to grow unless banks create $ (make loans) or the federal government runs a deficit. This is not rocket science. Monetary systems are based on addition and subtraction. The entirety of National Accounting & the Fed’s balance sheet could be done with an abacus.

    It’s payments that come from people’s earnings, which on the timeline [1] comes after the loan is issued, so as a point of logic the borrowers earnings can’t be funding the loan.

    Earnings are funding the interest however.

    [1] Arrow of Time, the causal arrow: https://en.wikipedia.org/wiki/Arrow_of_time

  19. Hayek's Heelbiter

    As Keen points out, classical economics posits “the Individual.”

    Epidemiology posits, I don’t know, data?

    Just curious. Has there ever been a mash-up of applying epidemiological statistical models to economies, which to me would be more objective and less subject to pre-supposition bias.

    Out of my depth here, so I’m throwing it out to the NC-ariat.

  20. John k

    Seems like some bank loans are better than others. If business uses the loan as investment to grow the business, income grows, so the increases debt payments ok. Borrowing to buy stock just boosts interest costs without increasing income, not stable.
    Rather than debt to .GDP maybe debt to borrowers income would be a better metric, as it is the rich are getting the wage increases, generally not the borrowers, not stable… so in this epoch picture is worse than growing debt/GDP.

    So the worst kind of private debt, now higher than 2007 with flat income. Unstable. And subprime autos and houses debt default rates up sharply. And growth of debt down a lot, not sufficiently compensated by deficit. It would be logical if at some point auto and house buying slows. Funny thing is…

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