How to Avoid Another Financial Crisis

How to Avoid Another Financial Crisis


a review of Steve Keen. Can we avoid another financial crisis? (Polity, 2017)

According to one reviewer, Steve Keen was “one of just 18 registered economists, out of a global total of around 36,000, who actually anticipated the global financial crisis” of 2008-2009. Keen’s book lays out where he thinks mainstream economists have gone wrong and what they and the politicians they advise need to learn. Keen is not hopeful either party will actually take a new approach. They relish their positions in society for they are the only “social scientists” who advise the most powerful. They are the priesthood for a corrupt system.

The forecast of official economic bodies and the Central Banks was that 2008 was going to be a good year. However, by the end of Dec 2007, unemployment went up to 5% and the financial markets were in turmoil. In 2008 and 2009, unemployment rose faster than at any time since the Great Depression (1929 – 1941). In mid-2009, inflation turned negative, something that had not happened since the end of the Korean War in 1953. Economists in authority responded in sheer panic.

In the decades before 2008, with each new cycle, the unemployment rate and the inflation rate had gone up less than the last cycle. The period was called “the Great Moderation”. The economics profession concluded that they had figured out how to successfully manage a modern capitalist economy.

Keen first looks at how the mainstream economists construct their models. The economists start their model building with the assumption that the conduct of individual consumers and companies in maximizing their benefits determines the behavior of the economy. Keen makes his model starting with the economic categories of creditors, wage earners, employers and governments, and it is the interaction between these players that determines what happens in the economy. Keen writes this way of constructing a model is more like what real scientists do.

What is most amazing is that mainstream economists do not include in their models the understanding that private banks are not “money warehouses” but “money factories”. How can this be after it has been empirically proven that banks create money out of nothing? Even the Bank of England admits it. Even more astounding is that a typical economic textbook may recognize these facts about banking in their chapter on finance, but they are not included in the models the conventional economists use for forecasting.

So let’s cut to the chase. It is ever-rising levels of private debt that is the key to understanding why the inevitable cycles of an economy can end up in an economic depression. Increasing private debt can create new demand for an economy but when it gets too large or slows down after a particularly fast increase, a depression can result. Keen cites the fact that “every economic crisis over the last 150 years has manifested: the combination of a private debt to GDP ratio of 150 percent or more, and an increase in that ratio over a five-year period of 17 percent or more.” (p.81)

The tragedy of a corrupt economic profession is amplified by the focus of the mainstream media on the Federal Government’s public debt. Ironically, the deficits of the Federal Government are one way an economy can be delayed from going into depression.

Keen is not completely original in his thinking. There was Irving Fisher’s famous 1933 article on debt deflation. Closer to our time were the theories of Hyman Minsky whom Keen credits throughout his book.

Because the ratio of private debt to GDP is above 150% in an ever larger number of countries, we face the possibility of another even larger financial crisis. Keen cannot say exactly when, since economic policy can affect the timing. Australia for example avoided the 2008-2009 crises with generous subsidies to first time home buyers.

So, what is the answer to the burning question posed in the title of his book: can we avoid another financial crisis? No, we cannot avoid another crisis if we don’t recognize the problem of private debt. But yes, Keen writes, we can avoid the next crisis if we follow the proposals he discusses, two of which I will mention.

A Modern Debt Jubilee proposes that the Central Bank of a nation with too much private debt inject money into all citizens’ private bank accounts but require that the money be used to pay down debt. Many people know that after the last crisis, the Federal Reserve injected billions of dollars into the accounts of the big banks in exchange for some paper of questionable value. The banks were saved but not the indebted economy.

Keen just barely mentions Modern Monetary Theory (MMT). This idea and the U.S. Constitution assert the right of the Federal Government to create money. MMT suggests the Congress spend enough new money into the economy to achieve real full employment. Government spending need not be limited to its income – through taxes or borrowing – like is the case with consumers, companies, states, and cities. It is the only institution in society “not revenue constrained.” (p.120) The implications of this are huge.

Keen is an outsider and does not think his ideas will be used by policy makers. He supports the private enterprise system but thinks private banking must be reformed and private debt limited. However, the Bank of International Settlements is now keeping track of the levels of private debt in all economies.

One Comment

  • JeanD

    I really appreciate you doing this research, reading and reporting back to us John. An thanks for your MMT comments at the end. It is important for people to recognize that there is a difference between local and federal monetary policy.

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