It was a couple of years ago when I first came
across Prof. Steve Keen’s lectures. In
an effort to understand the root causes of the financial crisis, I discovered in
his lectures an internally coherent and consistent line of thinking that
offered a much more realistic explanation of the crisis. I am not an economist or an expert to make a
judgment on the validity of Steve Keen’s contribution to economic thinking, but
I am sure that if democracy is to be saved in the country where it was born,
the only constructive approach is a new dialectic. I simply had to talk to Steve Keen and to try
to get across his ideas and views on Greece.
The result was Steve Keen’s first ever interview that appeared in the Greek
media.
AN INTERVIEW WITH STEVE KEEN
Q:Nikolaos
Karatsoris, A:Prof. Steve Keen
Q: In 2005 you were one of the first economists who predicted the
crisis. “The crisis can only be
understood from debt dynamics”, you had said in a seminar. Why didn’t they see it coming? Is there something wrong with macroeconomic
theory?
A: Neoclassical economics do not
include debt in their thinking whatsoever and this is a particular fallible of
the conventional school of economics. It
emanates from sometime early in the 1950s from an attempt to include supply and
demand analysis to every aspect of the economy including the money market; if
you are going to apply supply and demand thinking they have a downward sloping
demand curve, so the higher the price the lower the demand, the lower the price
the higher the demand, and an upward sloping supply curve. To apply that to the money market you have to
somehow argue that there is one group demanding money and another one supplying
money and that the intersections of those two functions give you both the
quantity being supplied and the price of that money. That’s the theory of loanable funds. Now prior to that vision of finance coming to
dominate, so that trying to use the supply and demand paradigm which is at the
heart of the neoclassical school and to apply that to money, now before that happened
even back in the 1920’s and earlier you can find writers like Arthur Pigou who
was the main conservative rival for Keynes with the General Theory. You can see him talking about the supply of
money being determined by a bank’s ability to lend and saying that banks can
create money simply by creating a loan and therefore creating a deposit. Even in Arthur Pigou’s work you can find the argument that I made
that demand is the income plus the change in debt and you can therefore
effectify a very strong correlation between change in debt and global economic
activity. Consequently the vision,
before we got the 1940s-1950s revision of the economics by the American
economists, was more realistic about the actual functioning of the money
system. Now you have this globally collateral loanable funds
model which means that they simply don’t have to consider what the banking
sector does. They treat the banks as
what they call intermediaries between savers and borrowers. Effectively if you like they regard the banks
as the market place in which the buyers and demanders of money meet. There is absolutely no role of the banks
themselves in determining that supply.
That’s their vision.
Q: Banks have been falsely viewed as intermediaries between savings and
investment. Yet banks are credit
creators. Is there a need for credit
creation in a modern capitalist economy, and if yes how do we reconcile this
need with the need to prevent the formation of Ponzi schemes? Is the abolition of fractional reserve
banking and monetary reform part the solution?
A: Well, that’s the trouble. I don’t think that alone is the cause of the
problem. For example I will give you an
illustration of Islamic Banking. I had
been invited to speak at a conference on Islamic banking; and of course the
whole idea of Islamic Banking is to prevent the exploitation of the borrower by
the lender. If you look at the Quran
you can see that Mohammed was a trader who hated being exploited by the money
lenders who financed the ventures. So
they find every possible way to say that if you are going to lend money you
have to share in the risks, so if the venture doesn’t work the bank doesn’t get
their money which is very very different from the modern situation, when the
venture doesn’t work, tough luck, the bank still gets their money if they forfeit
the assets of the borrower. So the whole
vision is to prevent exploitation of the borrower by the lender but when I
asked this Islamic Banking group where these halo funds were invested, the answer was in real
estate.
Fundamentally they are using a halo system which is supposed to
prevent from exploitation to finance an asset bubble. My point is that even though the Islamic
System is designed to prevent exploitation, they were still financing exactly
the same source of asset bubble Ponzi schemes, that the non-halo ordinary interest-charging
finance were funding. So my feeling
about abolishing, I don’t say fractional reserve system, but abolishing the
capacity of banks to create credit, and then handing that power over to the
state, is that there is no guarantee that that lending would not end up going
into asset bubbles rather than going into productive investment where we
actually want that money to go.
Q: How do we change that?
A: I am not a radical in the sense of being someone who
wants substantial social change because I am very aware that if you have a
proposal for a major social change you really can’t be sure of what will happen
on the other side of it. Society is a
very complex place. My preference would
be to try and set very basic rules, make it difficult, almost impossible for
that positive feedback loop to exist between the level of lending and asset
prices. Because the problem is that when you lend money you actually drive up
the price of assets. So there is a
positive feedback loop between increasing the level of lending and increasing
asset prices and that in turn gives you the spiral. And that would apply in any
system, even if you have one where the government is creating money and then
the banks are lending the money out without actually creating credit. Those
banks could still lend to finance an asset bubble and when of course when the
asset bubble broke down, the group that will be blamed for the break down would
be the government money creation system and not the banks themselves. We
can see that in a parallel right now, they are talking about bailing out Greece
but we all know, what they are doing is bailing out the banks that lent to
Greece. The money is not going to Greece
at all.
Q: What do you suggest?
A: To me, there are a lot of ways which we can break
that positive feedback loop. Two ways that
I can see to break it, is set up something where you have a negative feedback
between the level of lending and asset prices.
That’s what I mean when I talk about this idea of the Property Income
Limited Leverage, the PILL. The idea
being there that if you want to look at it at all times you have to have an
easy way to prevent a property bubble or bring it [the PILL] in when a property
bubble has burst. If you already had a
property bubble it would be a way to exclude people who can’t afford to buy in
the housing sector in the first place.
In places like England for example you might need a 400.000 pound deposit
to buy a house in London; anybody who has profited out of the boom already,
before the boom has burst, can quite easily raise 400.000 pounds from previous
property sales. But something on which the
maximum amount that can be lent is based on the income of the asset being
purchased and not the income of the borrowers and set that out, write that into
law; and a similar thing with share prices.
I would actually ban margin lending outright. I ‘d say that if you are going to be buying
shares you have to buy shares with your own money, you can’t do it with margin
lending and then I am still not sure about the idea of another proposal I call
the jubilee shares. That is where you
have a certain limited number of times that a share can be transacted on a
secondary market after which the share would no longer last in perpetuity. Let’s say that the idea being there that the
share can be sold 10-20 times.
Q: What happens
to the ownership of the share?
A: It can still be bought and sold. Whoever has bought the share owns the share
and lasts indefinitely until the company falls. Whoever owns the share owns it
but for a certain number of transactions and the share changes from a
perpetuity into a time-limited share like a 50 year share. And therefore if you‘d buy it after it‘s been
sold a number of times what you are buying is an income flow from the dividends
for 50 years but not capital appreciation.
Q: What will
happen after the expiration of the time limit?
A: Then it’s cancelled
Q: What happens to
the underlying asset?
A: The company itself would still exist. Its share would be cancelled like a share buyback
only without any money paid over. What you
might even do is a share buyback at the 50 year mark and the person who owns
the share at that time would have the original purchase price of the share
refunded to them.
Q: You referred earlier to the bank bail outs and to what happened to
Greece. We have been bailing out the
banking sector at a huge cost for society.
The current bank resolution proposals of the European Union treat
depositors as shareholders and under certain conditions they will be requested
to bail-in failing banks. We have seen
what happened in Cyprus. What kind of
capitalism is socializing the losses and privatizing the profits?
A: Disgusting! It’s stupid, it’s a stupid idea! It’s capitalism run by the ignorant! They don’t realize that if you actually bail
depositors in you are cancelling money.
They say let’s run capitalism, let’s destroy 40% of the money and see
what happens! What happens is a
depression. It’s phenomenally
ignorant! The one lesson you think you
would have learned from the Great Depression is you don’t let deposits sail out
of banks, because if the deposits sail out
the money supply contracts and you don’t go just into a debt induced
recession, you are going into a money destruction induced recession. Unbelievably stupid! It just shows the price we pay for ignorance
about economics.
[I was startled, not so much by the
rhetoric, but by the realization of the absence of similar rhetoric in Greece
where these decisions are not condemned as stupid and dangerous.]
Q: Is there a path of exit from those the so called “unconventional” monetary
policies or is this path a step in the dark?
A: The only workable path exit of exit
is, when they stop or reduce quantitative easing it will mean that interest
rates in the long end rise, which therefore increases the cost of borrowing and
also means that riskier assets are less attractive than they were beforehand. So what they have actually done by QE, they
haven’t injected any money into the economy, there is some way that they can
get it in there if they buy off shadow banks, then they do inject money into
the economy that way, but then of course it only gets spent on Wall Street
assets. So you are likely to have an
asset market fall when this is done, I think that it is quite good that there
will be a stock market fall, a substantial stock market fall in America and
globally when they start reducing QE.
But the money itself that the government has built up there, I mean,
those bonds that it has recovered parallel to excess reserves held by the
banks, all they have to do is sell those bonds back to the banks again and mop
up the excess reserves. Now when they do that, the government is going to sell
those bonds at a loss, so it is another injection back into the banking sector
again. It will be the same like as if it was a repo program, they will buy them
back. They sold them (the bonds) at an
elevated price and buy them back for a depressed price, there‘ll be another
effective monetary transfer from the Federal Reserve and similar Central Banks
to the banking sector, more profits for them.
But in the process you are likely to see stock markets declining.
Q: If QE, as it has
been applied, is not the solution, what would be the effect of tapering?
A: Just basically reversing the trend is asset
markets.
Q: This means
deleveraging.
A: Ultimately yes. You are likely to have some deleveraging to
some extent. People who borrowed to get
into the share market will find that they are losing money in share market and will
be forced to delever. If you have a
margin call, and there is a huge potential for margin calls now in America,
because margin debts are close to historical heights once more, when that happens the easiest way to get out
would not be to liquidate the shares but to liquidate other assets. This will take the wind out of the housing
market as well. There is a credit driven
boom going on in America right now in the real economy that’s why the economy
is recovering so much, particularly business borrowing has risen a great deal. But at the same time, the margin debt started
to decline, now a few weeks taken out as well, and the share prices really
start to fall over, then you get that what they properly call a positive
feedback effect and a negative impact in the downward direction in the share
market as declining margin calls means declining share prices as well. People will find themselves being wiped out
from that market. You will have
potentially a burning real
economy with rising levels of debt for borrowing for some business investment
but a declining share market.
Q: Lets’ talk about Europe. In an
article last year you proposed that the Euro “is the national currency of a
country that does not exist” and therefore it is not a currency; you proposed
the Euro becoming the SDR of Europe. If
we don’t adopt the idea of a parallel currency, the euro-drachma pegged against
the euro after letting it flow for a while, do you see another way out of the
crisis for the Eurozone if the Single Market is to remain at least intact or will
the Eurozone eventually break down.
A: I don’t know how people in Greece
are coping with the level of unemployment right now as the declining income
feeds more tensions in public services. It
seems absolutely mind boggling if people can tolerate that. I think at some point you are going to give
rise to fascist forces taking over. The
right does the right thing for the wrong reasons at the right time. That’s my own worry, that you‘ll have at some
stage the social pressure getting so great, you will have Golden Dawn [a far
right Greek political party] get the sufficient level of votes it takes to form
a government and do the usual stuff they do.
There’s such a political stalemate in Europe over the need to preserve
the Euro as a way of preserving European unity but the reality of course is driving
Europe apart. There can also be like a
short term low level revival from the level you were driven down so far, as it
happened in Greece and Cyprus in particular, you know you get to the level
where you suddenly look cheap to people for holidays and for selling
agricultural products; so you will get a bit of a bonus out of that so that you
don’t get right at the very bottom and then you can get a revival from the
European Union who can claim credit for it bizarrely. That might keep you floating along a bit
longer, but of course when you are continuing to squeeze people’s incomes and
continuing to have such high levels of unemployment at some point you are more
likely to have either social break down or either see sensible political reform
by the current political power.
Q: So our options are
a national currency, a parallel currency or there is no future in the Eurozone
unless we have some kind of reform towards a United States of Europe.
A: Yes which I can’t see happening.
Q: Austerity for Growth. It seems a
paradox. Greece’s nominal GDP has
declined by 21%, unemployment has risen from
about 8% to almost 28%, loans to the private sector have declined by about
20% from its all-time high, employee
compensation has declined by 32,5%, investment has collapsed, direct and indirect taxes have risen to
unbearable levels, non-performing loans stand at about 30%, there is a
deposit-loans gap of about 60bn euros, that’s about 30% of GDP, and the banks
despite the recapitalization are continuing to contract credit and ratios of
both public and private debt to GDP are steadily worsening due to GDP
collapse. This is an economy in ruins. Given
the fact that our public debt is external and held mainly by Eurozone
countries, the ECB and IMF, whether we stay in the Eurozone or exit is there
any viable solution without a significant debt haircut? Wouldn’t currency devaluation exacerbate the
problem?
A:
I don’t think it would make the problem any worse. That’s a tragic situation you are
describing. It’s all being caused by
reducing money supply and circulation.
You got loans exceeding deposits by that enormous margin courtesy of the
internal devaluation while still maintaining loans.
Q: That’s actually
money that fled from the country.
A: Yes, Germany and France mainly. That’s the horrifying picture of the 1930s
being replayed now. That is what brought
Hitler to power; he refused to pay the debts.
By refusing to pay the debts the huge financial burden was lifted.
Q: It’s irrelevant then
whether we stay in or leave the Eurozone unless there is a haircut or a debt
jubilee.
A: That’s right. Definitely!
Q: Do you think that a
haircut is politically viable at the moment given the fact there was a PSI and
all the debt at the moment is held by sovereign countries, the ECB and the
IMF? Is it politically viable for Merkel
to go to the German taxpayer and say that if we want to get out of this mess we
have to reduce the Greek debt?
A: I do not think that this is going to
happen with the current political leaders.
They are all totally obsessed with maintaining the euro but it’s
politically viable if somebody wants to break the political rules. If they do it there’s nothing that NATO can
do, nothing the EU can do to stop somebody saying we are not going to pay the
debts. That’s it, they are written off;
and if they do that, then all the caveats that are part of the bond contracts
become operative, so you get automatic default.
There’s no way that current political leaders will do it but there is no
way that they can stop somebody else doing it.
It breaks the rules.
Q: In the case that
Germany or the Eurozone countries do not accept to negotiate the debt, do you
think that it is a viable option for Greece to stop servicing the debt?
A: Well, the same way was for
Iceland. Iceland did the same thing.
Iceland refused to service the debts.
Q: That means an exit
from the Eurozone.
A: They had their freedom because they
were not part from the Eurozone but the same thing applies even if you are part
of the Eurozone. What they can say is
that we don’t get the euro anymore, well that’s ok, we already print our own
euros, which you do of course, and we already honor you know anybody who pays
for an asset by making an account transfer in Greece to somebody else’s
account; in Greece it works fine. What
they will do is confiscate Greek assets overseas, that certainly you can’t stop
them doing, so you have that political issue, but that’s hardly an issue for
the working class in Greece. It’s an
issue for the ruling class, but not for the working class.
[In the minds of Greek people leading
economists who opposed the austerity measures or supported alternative
approaches and some even a euro-exit have been portrayed as the demons that either
did not understand what was “good” for Greece or were planning the destruction
of the European Union. The average
citizen in Greece has been brainwashed and this is an obstacle that is worth
the effort to overcome it. Shifting the
focus of attention from Greece and the EU to the global financial and monetary architecture,
to the role of banking regulation and supervision, is a line of thinking that I
hope transcends dilemmas.]
Q: Is there a credit boom-bust cycle initiated
by capital requirement accords under the Basel agreement?
A: Oh yes! I was sitting next to Bill White
at the INET conference in Berlin about 1,5 years ago and the
discussion of Basel III came up and he leant across me and said when the rules
for Basel II came across his desk his heart has faint. He understands Minsky, if not better than me,
certainly as well as I do. He said the
whole idea about trying to specify which assets were safe was going to lead to
leverage of those assets by the banking sector.
Q: Since the
preliminary discussions between the Bank of England and the FED in 1986 that
resulted in the first Basel accord, a recurring pattern of national
deregulation, supranational regulatory supervision seems to have emerged
leading to boom bust cycles.
A: One thing that Basel did was to
encourage banks to sell securitized loans and get them off their books. There is a securitization boom driven by
regulation as well. Of course
securitization was under the myth that you actually reduce risk by
redistributing it or reduce uncertainty by reducing the ownership of assets
that its future value is uncertain.
That’s insane. That is what we
have happened. You can’t underestimate the
extent to which banks are going to arbitrage asset regulations but the
regulators almost always do. If you
rely on regulators to enforce things, first what they are going to do is do it
too slowly or do it badly, create rules that other people can then exploit and
get around and still not break the law and ultimately fail to succeed in
controlling the people they were supposed to regulate. If you set up something as simple as a judge
who can say that if you breach this rule you are in jail, as much as I have
some critical attitudes toward the law as well, it’s much harder to corrupt the
judges than to bend regulators. There’s
something straight forward and simple there on that front like the idea of the
PILL and like Jubilee Shares relying on the sanctions for breaching where the
judges get to say whether it happens or not.
That is more likely be effective than anything regulators are likely to
try to do.
Q: An institution like
the BIS, not accountable to anyone, can impose banking regulations and
effectively ignite deleveraging. On the
one hand it maybe desirable since the aim is to reduce the risks, but on the
other hand it ignites a credit bust. Is
this something that we need or should we transfer that power to institutions that
at least have accountability through representation, like the IMF?
A: BIS is the private version of what a
clearing house is supposed to be. I ‘d
like to see something that brought in the International Clearing Union
specifically as a way of enabling international financial transfers to occur in
supporting trade rather than having an organization which tries to regulate the
behavior of banks. You said 1986 a while
ago, I think 86-87, the crash of 87 and the aftermath of that, when the central
banks tried to actively manipulate the economy, based on a completely flawed
model of how the economy actually operates, that’s what really gave this asset
bubble we are in complete overdrive.
It’s a sign, certainly if you don’t know what you are doing, you are not
going to do what you do well. That’s
partly the dilemma. Secondly, I don’t
think it’s an effective mechanism in the first place. It’s far better if it becomes a way of
enabling commerce to occur rather than an attempt to control commerce. Ultimately
it leads to situations that people can exploit and create credit bubbles out of
which they‘ve done ever since 1987.
Q: Do we need a bancor
as Keynes described it?
A: Yes we do. The absence of that is the major
issue why the system became so totally crazy, because you are enabling a
national currency to be used for international trade. And that has just basically enabled that
particular country to abuse the rules of money as Americans have done but of
course ultimately at its own expense, because I think the large part of why
Americas’ manufacturing sector has been denude is the capacity to buy goods
just out of their currency’s commercial strength rather than out of their
economy’s industrial strength. We would
have had much less of a mess with bancor than we have with the American dollar
being the international reserve currency.
That is why I was pleased to see the Governor of the Chinese Central
Bank back in 2009 call for something like that.
We have to revise Bretton Woods, and please God, not held in America
this time. If we have that happening at
least we‘ll be arguing for a sensible system rather than one which is at its
hand imperialist which is what the Americans wanted.
Q: So we need a new
Bretton Woods.
A: Yes, but not in Bretton Woods.
Q: “Rand is mad”, you
had said in an interview, “humanity has always been a combination of
competition and altruism.” Is there an
Ithaca and hope for John Galt or is it impossible to escape from the hopeless
search for the mythical Atlantis?
A: We
can get out of it. We need to have a
more complex vision of how the economy operates and how society operates and
those simplistic notion that people like Ayn Rand and Milton Friedman. And the trouble is we‘ve been dominated by
those simplistic notions of a complex system.
Those simplistic notions exaggerate the importance of competition and
understate the importance of cooperation as part not only of the nature of
human society but also of humanity. We
are not homo economicus nor is society utterly an economic society. A vision of both cooperation and competition
is essential to a well-functioning economy.
If we have it I think we can function moderately well but of course in
the meantime the other major crisis we haven’t even come close to addressing is
climate change. That’s more likely to
force us than anything else to thinking in a cooperative fashion because there
is no way that we can competitively solve that problem. So I don’t think we are out of the woods by
any means, if we solve the financial crisis, we‘ll just move to the next one.
This interview ended somewhere here. I honestly believe that if not new approaches
to economic thinking become widespread, at least in my country Greece, then the
very idea of democracy will be threatened from the radicalization of the
electorate. I would be ashamed of my
country's civilization if we yield in our desperate search for solutions to
uncivilized alternatives. No matter how
idealistic this may appear, I believe that it is the duty of my generation to
do everything possible to present to our children an alternative vision for a
better future or our children will rightly so accuse us in the future of doing
nothing else but just sitting and watching destruction spreading everywhere. That was my aim. I hope Prof. Keen will be lenient with my
ignorance and I do hope that this interview has served its purpose in Greece.
Thanks to the effort of Alan Harvey, Prof.
Steve Keen will visit Greece for the first time in June this year. The Aristotle University of Thessaloniki will host a seminar on debunking
economics on the 18th of June 2014.
The seminar is organized by Prof. Dimitris Mardas, the Society
for Economists and Entrepreneurs and IDEAeconomics.
Further details will be announced.
An edited version in the Greek language of this
interview appeared in capital.gr on January 29th 2014. This english version was published at IDEAeconomics on May 16th 2014.
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