Yesterday, we launched Steve Keen’s EconComics on Arktoons. If you’re inspired to dig a little deeper in order to understand the very important role that debt plays in the economy, I would encourage you to read this extended essay on the subject written by the greatest living economist.
You may wish to keep in mind that Steve is a Man of the Left, whereas I am a Man of the Right, to the extent those labels even apply to economics anymore. What that means, in practical terms, is that while our perspective on the optimal solutions tend to differ, our perspective on the current state of things tends to not only be very similar, but to have far more in common than either of us do with the average Neo-Keynesian economist like Paul Krugman or Neo-Classical economist like Thomas Sowell, neither of whose models even begin to take debt into any account at all.
Regardless, Steve is on the very, very short list of people whose opinions I always take seriously and seek to understand, no matter how extraordinary or unlikely they may strike me at first glance.
Below is a selection from his interview with GQ Spain, so read the whole thing there.
GQ SPAIN: What is the role of public debt and private debt in the next great financial crisis?
STEVE KEEN: If conventional economics were correct, then there shouldn’t have been a crisis at all in 2007—and this is exactly what mainstream economists said at the time. In June 2007, two months before the crisis began, the Chief Economist of the OECD predicted that “sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment” (Cotis 2007 , p. 7).
Since there was a crisis—the worst since the Great Depression before Covid hit—there must be something wrong with conventional economic thought. And there is, because it asserts that the actual details of money don’t matter to macroeconomics—that the macroeconomy can best be understood by ignoring money, and treating the economy as a barter system. To quote a Neoclassical economist on Twitter:
Most people who teach macro do it by leading people through simple models without money …You can even do banks without money [yes!]. And it’s better to start there. Then later, study money as it superimposes itself and complicates things, giving rise to inflation, exchange rates, business cycles.
With this belief, they have never built a framework for analysing how money is actually created. Instead, they developed a “supply and demand” model of lending called “Loanable Funds”, where savers lend more when interest rates are high, and borrowers demand more when interest rates are low, and the market sets both the quantity lent and the interest rate. In this model, banks act as “intermediaries”, taking in deposits from savers and lending them out to borrowers. In their model, if the government enters the market as a borrower, then it adds to the demand for money, thus driving up interest rates and “crowding out” private investment, which lowers the rate of economic growth.
In 2014, the Bank of England categorically declared that this model was wrong: banks do not take in deposits from some customers and lend them out to others, but instead, “Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits” (McLeay et al. 2014, p. 1). This means that private lending doesn’t cancel out, as the mainstream still believes. Instead, rising bank debt creates new money and causes a rising amount of spending, while falling bank debt destroys money and contracts spending. This is obvious in the data: when credit is positive and rising, unemployment falls; when credit is negative and falling, unemployment rises.
America shows the same pattern: rising credit, falling unemployment; falling credit, rising unemployment.
It’s also obvious when you look at the actual way in which money is created: I invented a software program to enable that, called Minsky. It very easily shows that mainstream economics have things backwards: rather than bank loans shuffling existing money between savers and borrowers, bank lending increases the money supply; and rather than government deficits adding to the demand for money, they add to the supply of money.
The process of money creation is actually very simple, as the Bank of England pointed out. Most money today is in the form of bank deposits. To create money therefore, you have to do something that adds to bank deposits. Both bank lending and government deficits qualify, but in different ways.
Bank lending increases deposits while repaying debt reduces deposits, so if net lending is positive, bank deposits increase, and hence so does the money supply.
Since people borrow in order to spend, rising private debt stimulates aggregate demand and asset prices, making the economy—and the government—look great to conventional eyes. The economy booms, unemployment falls, and booming tax receipts make the government look like it is responsible by running a surplus. But if the rate of growth of private debt—otherwise known as credit—turns negative, then everything unravels. The economy goes into a recession, unemployment rises, asset prices fall, and government debt increases—and if it didn’t, the recession would be far deeper.
This is because, as well as being wrong about what banks do, the mainstream is also wrong about government deficits and government debt. Rather than deficits meaning that the government has to take money away from the private sector—which is what the mainstream thinks the government does when it sells bonds to cover a deficit—the deficit creates money by increasing the bank deposits of the private sector.
In simple terms, by not studying the accounting involved in government deficits, they have wrongly classified them as increasing the demand for money, when in fact they increase the supply of money. So all the arguments they make have it back the front: deficits crowd in private spending and investment by increasing the supply of money and, if anything, they drive down the interest rate, rather than driving it up.