The inability to account for debt and the total failure to understand the relationship between banks and loan creation are two of the reason mainstream economics is so hapless with regards to producing functional models. The world’s most important economist explains that his professional colleagues are simply ignoring one of capitalism’s most pressing problems:
I like Joe Stiglitz, both professionally and personally. His Globalization and its Discontents was virtually the only work by a Nobel Laureate economist that I cited favourably in my Debunking Economics, because he had the courage to challenge the professional orthodoxy on the “Washington Consensus”. Far more than most in the economics mainstream—like Ken Rogoff for example—Joe is capable of thinking outside its box.
But Joe’s latest public contribution—“The Great Malaise Continues” on Project Syndicate—simply echoes the mainstream on a crucial point that explains why the US economy is at stall speed, which the mainstream simply doesn’t get.
Joe correctly notes that “the world faces a deficiency of aggregate demand”, and attributes this to both “growing inequality and a mindless wave of fiscal austerity”, neither of which I dispute. But then he adds that part of the problem is that “our banks … are not fit to fulfill their purpose” because “they have failed in their essential function of intermediation”:
Between long-term savers (for example, sovereign wealth funds and those saving for retirement) and long-term investment in infrastructure stands our short-sighted and dysfunctional financial sector…
Former US Federal Reserve Board Chairman Ben Bernanke once said that the world is suffering from a “savings glut.” That might have been the case had the best use of the world’s savings been investing in shoddy homes in the Nevada desert. But in the real world, there is a shortage of funds; even projects with high social returns often can’t get financing.
I’m the last one to defend banks, but here Joe is quite wrong: the banks have very good reasons not to “fulfill their purpose” today, because that purpose is not what Joe thinks it is. Banks don’t “intermediate loans”, they “originate loans”, and they have every reason not to originate right now.
In effect, Joe is complaining that banks aren’t doing what economics textbooks say they should do. But those textbooks are profoundly wrong about the actual functioning of banks, and until the economics profession gets its head around this and why it matters, then the economy will be stuck in the Great Malaise that Joe is hoping to lift us out of.
The argument that banks merely intermediate between savers and investors leads the mainstream to a manifestly false conclusion: that the level of private debt today is too low, because too little private debt is being created right now. In reality, the level of private debt is way too high, and that’s why so little lending is occurring.
I don’t agree with Keen on everything, but he is the most important, most revolutionary economist in the world today. And he is dead-on with regards to both the problem of private debt as well as the way in which banks originate, not only loans, but credit money itself.