Monday, May 08, 2017

About The Next Great Crash


Aggregate private household debt, 1990-2014. Consumer debt is measured on the left-hand scale; mortgage debt on the right-hand scale (source).

by Gaius Publius

"In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way [money is created] is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money."
—Bank of England ("Money creation in the modern economy")

Governments create money and banks create money. Governments create money by spending. They send you $100 for, say, several cartons of paper from your small paper supply store, after which you have $100 and they have paper. Where did the $100 come from? The government "printed it," perhaps literally. Nevertheless, you have $100 to spend and are in debt to no one.

Banks create money by lending. You go to a bank for a $100 loan. They add $100 to your side of the ledger as an asset they've given you, and add $100 to their side as a debt you own them. You walk out with $100 you can spend, and they look forward to collecting interest until you pay it back.

(No, banks don't take money from reserves or deposits to lend you money. If the government had a rule that said banks had to hold no reserves, they could still lend you money. Read the quote at the top again from a Bank of England paper, or consider this Forbes article, "Banks Don't Lend Out Reserves," which says essentially the same thing: "[W]hen a bank creates a new loan, it also creates a new balancing deposit. It creates this 'from thin air', not from existing money: banks do not 'lend out' existing deposits, as is commonly thought.")

Those are in fact almost the only ways that money — the thing in your wallet and the number in your bank account — come to exist. (A third way of money-creation is for governments to issue treasury bonds — also a form of "printing it" — but that way is entirely optional and doesn't pertain to this discussion. They could still just print the money directly, as money, if they wanted, and use that money to buy things. Treasury bonds are created for an entirely different purpose. Paying taxes, of course, uses money already created.)

Both of these ways of creating money — by governments and by banks — create an asset. But when governments create money by spending, people own the asset. When banks create money by lending, they own the asset, which they lend, and people own a debt — the obligation to pay it back with interest.

This is a Great Truth and should be memorized. In general, government-created money puts an asset in your hands. Bank-created money puts an asset in their hands.

Obviously, bankers would always prefer the economy to be supplied with new money by banks than by the government. Which is why governments are always being forced by bankers, to the greatest extent possible, into austerity budgets. It means more business, more profit, for them.

Bank-Created Money Competes with Government-Created Money

Banks — and the bankers who grow rich running them — love it when governments run budget surpluses, which means the government takes more money out of the economy than it puts into it. (A government budget surplus means that at the end of the year, the government spent less money than it took in. In other words, budget surpluses shrink the supply of money, making money less available to the public)

When governments run surpluses (which is sold to the public as enacting "responsible" budget policies), the economy is relatively starved of government-created money. Every dollar that the government does not spend is a dollar that's not available to anyone. So to get additional dollars — to make up the difference between what the public needs and what they have — the public has to go to banks and other lending institutions and put themselves in debt.

It should be obvious from this that banks will always favor "responsible" pro-austerity government policies, and will always work to enact them. When bankers succeed at enacting austerity budgets, they increase their take from loans and make out like bandits.

That's where we are now. Bankers have captured the political process and staffed the government with its own ex- and future employees. On the Democratic Party side, this practice of bankers running government budget policy goes back through Barack Obama to Bill Clinton, his banker-turned-Treasury Secretary Robert Rubin, and their proud budget surpluses. (Rubin went from Goldman Sachs to Treasury Secretary to Citigroup. He even gave his name to this set of policies: "Rubinomics.")

Bankers like Rubin and their Democratic Party acolytes preach austerity for government, try to run budget surpluses instead of deficits (i.e., take money out of the economy instead of supplying it), and the whole rest of the nation goes into debt to bankers when people need what the government failed to provide.

(Republicans preach austerity too, but run budget deficits when they have power. Deficits do create an asset, the money itself, but the money doesn't go to the general public. Most of it goes straight to their friends, often in the military-industrial-security industry. This time a lot of it will also go to the climate-change-creating fossil fuel industry.)

The Goal of Both Parties Is to Keep Household Debt High

While the total private debt — commercial or business debt and household debt — affects the whole economy as we'll see shortly, the household debt now drives our politics. And maintaining high household debt has been a goal of both parties.

When Democrats hold power, the government directly starves the economy of money (strives for "responsible" budgets) and bankers get rich creating debt. That's why households are so debt-ridden today, with mortgage debt, student debt, credit card debt and the like. It's why the whole rest of the country, the bottom 90% whose voices are never heard, no matter who they vote for, are feeling so fatally crushed, so ... pre-revolutionary, if you will.

When Republicans hold power, the government enacts deficit-creating budgets, but still keeps the giant mass of private debt in place so commercial banks and other lenders can continue extract interest.

Where does this leave the public? Drowning in debt by design, under either party.

Where does this leave the country (in addition to poised on the verge of revolt)? Poised on the precipice, the edge, of the next Great Crash, because unrestrained debt-creation drives boom-and-bust cycles.

The Structural Problem With Debt-Driven Economies

Earlier I wrote about the current U.S. debt overhang (the large amount of debt that businesses and the public are suffering under) and said, "No U.S. economic recovery is possible until the government stops protecting creditors at all costs and starts making it possible (or mandatory) for personal debt to be forgiven." I'm not alone in saying that.

That statement is still true, but the situation is actually worse than I said. It's not just that a recovery is impossible; it's that the crash part of the boom-and-bust cycle is on its way as well. The mass of private debt — household debt and business debt — is now so great that it will cause the next economic collapse, just as debt caused the last one in 2008. This is a global problem, since major economies around the world have refused to put the brakes on debt creation. (One of the worst offenders, by the way, is China, but they're certainly not alone. Economic growth in almost all Western nations is strangled by the overhang of private debt.)

Michael Hudson explains this in a review of a new book by Steve Keen called "Can We Avoid Another Financial Crisis" (h/t Naked Capitalism for the link; emphasis mine). Hudson starts with Keen's view of debt growth as systemic to unregulated banking activity. First, debt growth creates an economic boom, when the new money acts as a stimulus. But later, bankers become "exuberant," lend far, wide and recklessly to increase their own income, and debt repayment comes to dominate the economy, strangling it. This puts the economy in a downward spiral, leading to a crash. In a society that does not restrain bankers, rinse and repeat.

Hudson puts it this way:
It is simple enough to show that the mathematics of compound interest lead the volume of debt [both household and commercial 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 [today].
Mainstream (neoliberal) economics has no way to take this debt-driven boom-bust cycle into account, or even to see it for what it is, since neoliberal economics doesn't see debt as a driver of the economy at all. As Hudson says below, for them it's the old logic that "debt doesn't matter, because 'we' owe the debt to 'ourselves.'"
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). Krugman 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.”

[But 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.
For Keen, Hudson, Minsky and a number of others, this kind of economy — depending on unrestrained debt for stimulus, leading to debt-driven crashes — is malstructured and the boom-bust cycles are inevitable, built in. The only long-term solution, of course, is a restructured, debt-restrained economy, which implies quite a lot of government intervention — anathema to free market, neoliberal, Rubinomics true believers (and the bankers who keep them in power).

Barring that restructuring, economies entering bust cycles have only two choices — pop the bubble now, or keep the party going a little longer — and they generally take the worse one:
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. [...]
Again, this is where we are now. The U.S. economy and the world economy are both limping along at almost no growth, and have been since the 2008 crash. No one has seen a recovery except the very wealthy, the upper 1%, plus the upper 10% who run things for them. Banks are doing fine, better than fine in fact, because government policy both here and in Europe is to let no debt go unpaid. You can see the result. I hope you can also now see where this is leading.

"Irrationality" and Bank Lending

Classic, neoliberal economics sees the world as made up of "individuals" making rational decisions. Here's Keen quoting Ben Bernanke, a classic neoclassical economist (source here; my emphasis):
"Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior. [A footnote adds] 'I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go.' (Bernanke, 2000, p. 43)"
But the irrational often rules us all, especially hyper-wealthy bankers driven mad with greed, what Alan Greenspan, another classic neoliberal economist, quaintly called "irrational exuberance." Pathological monomania is another characterization, and it's not an anomaly, but a characteristic of this part of the cycle. (Even economist Jeffrey Sachs labeled as "pathological" the Wall Street bankers he had to personally deal with, a surprising statement coming from someone who used to work at the IMF.)

According to Hudson, Keen's solution to this failure of vision is to see the economic world as populated, not with individuals like "prudent savers" (banks) and "spendthrift" borrowers (their customers)," but with "basic economic categories – creditors, wage earners, employers, [and] governments [who are] running deficits (to provide the economy with money) or surpluses (to suck out money and force reliance on commercial banks)."

A Choice — "Modern Debt Jubilee" or the Next Great Crash

Keen does have a solution to the problem of avoiding the next great crash. He calls it a "modern debt jubilee," a massive conversion of debt into equity. Hudson describes this as essentially a swap of equity for debt. About this, Hudson writes, "The intellectual pedigree for this policy to keep debt within the ability to pay was laid two centuries ago by Saint-Simon in France. ... As a transition from [today's] debt stagnation, [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. Non-debtors would keep the transfer payment – so as not to let demagogic political opponents accuse this plan of rewarding the profligate."

That is, everyone gets a gift of money in their bank account from the central bank — the government's bank, which again creates new money. Debtors are required to apply the gift to their debt. Non-debtors get the gift as well to avoid the inevitable political attack that, if only debtors got the gift, we'd be rewarding only the "undeserving."

Pretty slick idea. Some wealth rebalancing (though not much), considerable debt destruction, with a side of economic stimulus. That would keep the next crash at bay.

When Pigs Fly, or Sanders is Senate Majority Leader

Keen's suggestion will also, my realistic socialist mind tells me, never happen. If it did, we'd be living in a world in which the Democratic Party chooses Bernie Sanders to replace Chuck Schumer as Democratic leader of the Senate, and chooses to win elections again by standing with the people instead of big money donors, many of them bankers, who now provide most Party funding.

This could occur, of course, but look what happened to Sanders the last time he challenged the Party — every part of its ecosystem, including its media, worked to defeat him. And if Democrats won't stand for the people — and save the nation from the debt that's drowning it — who will? In our deliberately constricted political system, there's only one other alternative, and they'll always be no help at all.

Our Debt Is Their Income Stream

A final note — the newsy part of this piece, about the coming crash, is not the most important part. The paragraphs leading up to the news — my opening sections prior the discussion of Steve Keen's book — is much more significant, since it explains all you need to know about why banker-captured Western governments are so in love with austerity economics; why austerity guarantees your indebtedness; and why that's entirely by design.

Again: Government-created money puts an asset in your hands. Bank-created money puts an asset in their hands.

Our debt is their "income stream," and they will always stop at nothing to keep it that way, including inducing the first black president to destroy the wealth of his own community for their benefit (see "Obama's Other Legacy").

This austerity-created income stream must be interrupted and reversed, or we really will get that revolution I've been alluding to, and not just at the ballot box. (More on that problem in a later piece.)


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At 10:59 AM, Blogger Thomas Ten Bears said...

A perpetual motion machine is bound not only by the laws of nature but the rules of statistical probability to fail. It has grown too large, too diverse, too ... scattered. It will fail.

The Constitution mandates that the government, like providing postal service, mint the money. The Federal Reserve and the banking we enjoy are contrary to The Founders' intent and may well be unconstitutional.

At 1:15 PM, Anonymous Anonymous said...

An extraordinary piece. It simplifies things for the ignorant, but is essentially true in generalities.

It is useful to remember why the federal reserve was created. In short, it's there to insure the fidelity of our currency. It does not serve that charter any more. And it, in fact, serves to augment and enable the banks' creation of their wealth bwo creating our own subservience. Its monetary policy decisions have been for this purpose only since I was in diapers at least.

This is capitalism in its purest form. Absent altruistic governmental controls, capitalism SHALL extract all individual capital and convert it into the capitalists' capital.

We've been absent all forms of altruistic governmental controls since democraps passed and Clinton signed deregs, xxFTAs and, most damaging, CFMA and GLBA.

Of course, this all happened with the affirmation of voters every 2/4 years since 1980. The vast majority of voters are far too stupid to understand any of this... and they are also far too busy fearing official boogeymen and hating all the "others", as hate media tells them, to pay any attention to the ass-raping they've been going through at the hands of the government and capitalists.

Thus you get 2008, resultant austerity and the putin-drumpf-ryan health care denial... all with the enthusiastic affirmation of half the voters, at least.

When voters are pure evil AND dumber than shit, a democratic government cannot ever be any good.

At 2:16 PM, Anonymous Hone said...

Gaius, thanks for this article. So do you have any estimate on when this crash will occur?

At 2:55 PM, Blogger VG said...

Without careful reading, and clicking through the links, one might miss this really interesting interview with Michael Hudson.

"No U.S. economic recovery is possible until the government stops protecting creditors at all costs and starts making it possible (or mandatory) for personal debt to be forgiven." I'm not alone in saying that.

I clicked on that, (not alone in saying this) and it lead me to this fascinating interview

with economist Michael Hudson.

At 4:19 PM, Anonymous Ed said...

Example of bankers beating debtors into the dust: Until 1976, student loan debt was dischargeable. Then it went to 5 years in repayment before you could discharge. In 1990, it went to 7 years. In 2005, it went to never.

That foot on your neck? Think about it.

At 7:13 AM, Anonymous Anonymous said...

Hone, in answer to your question... who knows? But history might give some hints.

Before "NEW DEAL" reforms, the boom-bust cycle averaged about 12 years.

Absent any governmental controls, as we essentially are in now, I'd be expecting another "crash" by 2020 or so. This could be exacerbated, of course, by man-made stimuli.

I don't see a bank going poof just yet, like Lehman did which catalyzed the housing crash. I *DO* see a possible consumer contraction that might trigger something from that end. Since there was not really a "recovery" at the bottom, conditions in over half of all households is tenuous. Any 6-month jobs stagnation or summary jobs reduction could trigger a consumption crisis that might trigger a market "correction/crash".

And, of course, the orange-utang could start more wars, be exposed as a Russian puppet, sign his tax cut package (the debt balloon WILL burst at some point), start a mass arrest program of immigrants (ala the Nazi round-up of jews), declare martial law ... or all of the above.

But be advised that, due to all policy from both sects of the money party, it cannot NOT happen at some point. It's by design.


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