Steve Keen: The Deliberate Blindness Of Our Central Planners

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The models we use for decision making determine the outcomes we experience. So, if our models are faulty or flawed, we make bad decisions and suffer bad outcomes.

Professor, author and deflationist Steve Keen joins us this week to discuss the broken models our central planners are using to chart the future of the world economy.

How broken are they? Well for starters, the models major central banks like the Federal Reserve use don't take into account outstanding debt, or absolute levels of money supply. It's why they were completely blindsided by the 2008 crash, and will be similarly gob-smacked when the next financial crisis manifests.

And within this week's podcast is a hidden treat. Steve's character exposition on Greek Financial Minister Yanis Varoufakis. Steve has known Varoufakis personally for over 25 years, and is able to offer a window into his constitution, how his mind thinks, and what he's currently going through in his battle with the Troika for Greece's future.

Click the play button below to listen to Chris' interview with Steve Keen (46m:13s)

 

This is a companion discussion topic for the original entry at https://peakprosperity.com/steve-keen-the-deliberate-blindness-of-our-central-planners/

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This pod cast should be compulsory listening in every parliamentary chamber across the planet. 

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(At least in this model that we call Reality)
It sounds as though Prof. Keen is a scholar of Meadows. Let us be generous and assume that the ivory tower is gifted enough to understand the real world implications of the Limits to Growth and are just not going to go there.

Feralhen asked me about the moment of Price Discovery.  My best answer is that every lever will be pulled to delay that moment for as long a possible. Over here in Australia we are controlling demand by controlling the immigration rate. Of cause externalities are ignored. 

Man is not a rational animal, man is a rationalizing animal. 

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I hated economics when I was in college - but that's only because I didn't have this guy as my professor.  His version of economics makes sense.  All the bits hang together.
I like his modern debt jubilee, how banks generate money - and he's plugged into resource limits on a finite planet too.  How much better can you get?  The man is solidly grounded in reality.  The Varoufakis bit was icing on the cake.

I think I'll go listen to the podcast again.  I think its awesome we had him on.

BTW, Keen has a very clear explanation of why debt grows at an exponential rate over time - it has to do with the fact that the central banks never allow the debt from the most recent Ponzi cycle time to deflate - they feel the need to start a new credit cycle to deal with the previous Ponzi.  What results if you zoom out far enough?  Exponential growth in debt.  Not because of a structural problem in our monetary system about paying interest, it is because of human nature's endless desire to avoid economic pain - rinse, repeat.

We saw this very thing in the housing bubble: it was started in order to deal with the dotcom crash.  Now they're trying again … creating a bond bubble to deal with the deflated housing bubble.  Repeated bubbles + no time to deflate = exponential growth in debt over the long term.  And the bankers (who aren't part of the standard economic model) have no interest in "tapping the glass and disturbing the fish" - they want debt maximized, because that's how they make the most money.  Maximize debt, and you maximize banker income, and (as a side effect) its control of government policy.

At the core, we have a bunch of lawyers running the Fed, advised by a staff of economists who don't have money and banking as part of the important bits defining how the world economy works, egged on by bankers who have been defined out of the model so they can't possibly be at fault when things go sideways.

I'd say that the banking establishment finds this status quo all very useful.

"Its all about aggregate demand."  (Ignore the bankers, they don't matter)

And a Jubilee?  Can't free people from their (debt) slavery.  Not allowed.

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Over on zerohedege we have the Oracle himself. I invite you to count the number of times the word "equilibrium" is mentioned.  
Its a competition.  A bit like guessing how many jellybeans are in the jar.

http://www.zerohedge.com/news/2015-03-30/ben-bernanke-pens-first-blog-post-defends-fed-says-he-was-concerned-about-seniors

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Great podcast! General Equilibrium Theory has always been based on flawed, if not plain wrong, assumptions of marginal utility. Thank goodness there are economists working on alternate theories that move away from this gawd awful foundation of rational consumerism. I remember having this conversation awhile ago on this site and it was pointed out that the GE Theory merely replaced Value Theory. (based on labor, as well as including historical value) Something to consider.
I like how Keen wasn't afraid to call Chris's view of the FED "wrong." I'll bet Chris got a kick out of this since he was basically being accused of giving the FED too much credit. smiley

I also believe the idea of anti-fragility is built into the status quo of Equilibrium thinking, as Keen professes. Contrary to what those at the FED probably think, short-term targets are the only goals realistically considered, i.e., short-term binding contracts (leveraging) have become the deciding factor of keeping that equilibrium in place. Can you imagine the unraveling of those contracts if there were a massive jubilee? (even though there are some currently that create their own jubilee by walking away)

Regardless of the advantages to banks for maximizing debt, I think it is also somewhat human nature for many people to want the status quo, as Khanemann says in this video, some like the room temperature set at a constant 70 degrees, and if you don't have FU money to ride out the storms, 70 degrees feels pretty good:

https://www.youtube.com/watch?v=MMBclvY_EMA

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As Steve explained, it's even worse than that…the standard economic models have the assumption of not just a perfectly rational set of actors, but every one of them endowed with perfect clairvoyance…able to integrate all current knowledge into a framework that allows them to make perfect decisions.

This was needed because otherwise the models just didn't behave properly.

Which is why you have jokes like this one;  three economists are locked in a basement and are beginning to get hungry, but they are not worried.  Why Not?  Because soon enough one of them will just assume sandwiches to have always existed in the basement.

The real mystery is that despite the massive failings of standard economics over the past decades at explaining or predicting anything at all useful, their every word is still fawned over by the world…

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Well, that was unsettling.  I share Chris's slack jawed incredulity.  For some time I have been frustrated with how little credit Chris gave the FED.  I almost gave this podcast a pass thinking it was just going to be another central bank beat down. Surly, I though, intelligent people must know what's going on, they must have a plan.  I was fully prepared to accept that the plan might be to jettison most of the human race, not personal, just business.  To find that TPTB may not, no shit, honest injun, have any f***ing idea that their models and projections are insane is disturbing, to say the least.
I feel like a passenger on an airplane.  As a reasonably educated person I can look at a map, look at my watch, calculate the amount of time the airplane can continue to fly and realize that we're not going to make it to the destination we all bought tickets for.  Ok, the flight crew will find an alternate airport, travel plans will be disrupted, inconvenient and disappointing, but nobody is going to die.  Not going to retire to a warm sunny place and spend my golden years in leisure, but perhaps food, shelter and medical care. Plane keeps flying.  Hmmm, not good.  Flight crew must be looking for a place to crash land.  So, no retirement, work until you can't, die in poverty.  Not pretty, but there you go.  Plane keeps flying. It becomes apparent that the plane is on autopilot, the flight crew is oblivious, the cockpit door is locked and that we are going to fly straight into the side of a mountain.  

Cognitive dissonance.  Trying to wrap my head around the idea that we seem to be headed for the collapse of the industrial civilization bubble without any meaningful attempt at mitigation at all, bummer.

John G

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Why does this system (of debt-based money) keep compounding on itself in exponential fashion?  Steve Keen completely ducked this one… he just said that the FED economists, and others of the same Keynesian ilk, would rather not see government deficit spending/gov't growth, along with some comment (I forget) regarding his model that shows debts could be covered without exponential growth.   
My head is going to explode.  Maybe it's like 9/11… nobody could have seen it (the exponential debt-berg) coming… just a failure of imagination.  Riiiiiiiigggghhht.  

 

 

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This is one of the best descriptions I have read in a while, and it is scary to think how close to the mark these words come for me.  Whether it be discussions about over population, debt problems, sustainability issues, people having their perceived future retirement taken from them…all of these things are building.  If you take the plane analogy…it is amazing how many people are calmly sitting in their seats, just looking out the window…waiting for the plane to land.

With this description we can just hope that the plane analogy isn't right at all, that we are closer to the ground, riding smoothly along in a vehicle.  2008 was a pot hole.  Perhaps that next one will be a pretty nasty frosty heave.  Perhaps, just maybe, the future can be navigated. 

 

 

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That might depend on your definition of "isn't".  I don't think The Thing is going to let us off the hook that easy. From a Control Theory standpoint, things tend to break suddenly and permanently when you get to where we are.

Perhaps your local mileage may vary (?)

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  1. An economist who understands money creation/destruction.  cheeky

  2. Does he really appreciate the role of energy in our economy or does he share Zerohedge's  ignorance of peak oil and peak net energy ?  blush

  3. Thinks the Ponzi scheme could carry on for another 5 years in US and UK if we can continue our private debt expansion. smiley Let the party continue.

  4. Thinks that there should be a debt jubilee.  Savers will not be happy frown Zerohedge will be livid.

  5. He didn't predict much on Greece indecision No solutions apart from a debt jubilee, Europe would fall apart as the rest of southern Europe demand the same. Germany would go insane. Not good for peacefrown

 

Thanks Chris. Loved it. I'll go and hear the podcast again now.

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Is that a pole-zero diagram, Time2help ?  Not seen one of those for 30 years.  We don't design systems like that any more.  We just built them and see what happens; yep that works, lets roll it out; shit that didn't, just blown my face off. 

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Thanks!

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Well I didn't study economics in collage so I had to listen to the podcast several times to make sure I understood the light bulb moments that kept going off.
It seems to me that we, Mr. And Mrs. Middle America, the ones who work hard, pay taxes, fight in the wars and are decent people, are the backbone of this country.  So it is shocking to learn that those with the purse strings don't think in the long term.  They are apparently indifferent or clueless to the plight of us "Middle Class".  As I have said before we are being quietly exsanguinated (QE).  Gee the economy doesn't look good let's stick a straw in the goose that lays the golden eggs (we Middle class) and see if there is any blood left. (QE - 4 on the agenda?)

Living in the land of plenty is seductive. Private planes, private drivers, expense accounts, eating at restaurants, having someone clean your house and getting your clothes dry cleaned distances people from the main stream economy.  Heck I go to COSTCO, Wal Mart, SAM's Club or a mega grocery store and the abundance of products gives the appearance that availability and good times will last forever. Lack and want are not part of the American way of life, or so it appears. Those who steer our country are out of touch, short-sighted and indifferent.

That sound I have been hearing these last few years wasn't planes flying overhead it's the sucking sound of the straw that's removing the last amount of life-blood from us middle class.  And I thought I needed a hearing aid.

Cranky Granny

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JimH-

Why does this system (of debt-based money) keep compounding on itself in exponential fashion?  Steve Keen completely ducked this one...
Jim, I answered it.  My source: Steve Keen's other lectures.  He explains it in detail there.  However you have to have an open mind to truly understand it.  If you already have the "must create enough money to cover interest payments" belief system locked in place, your mind will reject the evidence - just like the neoclassical folks have rejected everything Steve Keen has to say.  They aren't stupid, but their entire life education precludes them from even considering his concepts.

The good news is, once you get it, you will wonder how you missed it in the first place.

The fact that I am involved in finance for a small business may have helped, actually.  Watching the P&L statements come by every month, and then watching the balance sheets, you start to understand instinctively how the flows (P&L) and the stocks (balance sheet) cannot really be mixed.  They do affect one another, but a stock is a stock (it just sits there, unchanging), and a flow is a flow (it varies every month).  And you need to manage both.

In this case, you use your flow (P&L) to slowly pay off the principal & interest on your stock (balance sheet loan liability).  Flow through the P&L is the key to making your interest payments.

You can have a $200k loan liability, $50k in the bank in assets, and making your payments are no problem as long as your cash flow is enough to make the $5k monthly payments.  There is no need to have "$200k + interest" sitting around on the balance sheet to service your debt.

Same thing if you borrow money for a house.  You don't need to have $300k + $30k in interest in the bank to be able to repay your $300k loan.  You just need an extra $3k/month in salary flow and you're good.

Example: to enable $1M in annual flows, our company needs only $50k in working capital.   (Ok, we need more, but it is possible to operate on that little).  We aren't going bankrupt.  We are profitable.  From a "system" point of view, our capital needs ($50k) are completely dwarfed by our flow through our P&L of $1M.  In a real sense, $50k of "fiat money created cash" enables $1M of annual flow.  If we had to borrow that $50k to enable our $1M of flow, do you think we could make the payments?  It would be easy.  Trivial.  Our $1M flow vastly exceeds our required $50k money stock - its a 20:1 ratio.

That's business.  Most businesses have a much larger cash flow over a much smaller working capital base.  Capital base was borrowed into existence, but the interest payments for that borrowed capital base are easily repaid from the rapid flows (10:1, 20:1) across the P&L statements of those companies.

Same is true for households.  Paycheck-to-paycheck America may have $5k in the bank, but they make $50k per year (i.e. $4100/month).  $5k in created-bank-credit "enables" maintaining the household on that income of $50k per year.  Another 10:1 ratio.  With such ratios, its quite possible to make interest payments on $5k.

Writ large, "the system" doesn't require that much in working capital to run.  Demand deposits (checking accounts) are 1.19 trillion, while total bank credit (total bank loans outstanding) is 11 trillion.  And this 1.19 trillion in borrowed working capital enables (provides liquidity for) a GDP of 17 trillion.

Flows make payments.  Not stocks.  If Keen were here, that's what he'd tell you.

 

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I offer solidarity.

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For those that don't know, Steve Keen's "modern debt jubilee" is this:
A one-time payment, from - the Fed, lets say - to every adult citizen in the United States of $50,000, of freshly printed bank credit.

There is a catch.  If you are in debt of any kind, you must use the money to pay down (or pay off) your debt.

Cost: perhaps $14 trillion.

No creditors take losses.  Every creditor is made whole.  No defaults occur.

And those who are debt-free, get to keep (or spend) that $50k.  No moral hazard.

It would be inflationary, but not as inflationary as you might think.  As we know, when debt is repaid, money is destroyed.  What debts would be destroyed?

Credit cards & auto loans ($1.2 trillion) and a large chunk of mortgage debt ($9.3 trillion) would more or less vanish.  US government-originated student debt ($842 billion) wiped out.  America's citizens would be (largely) private debt-free.

Banking would suffer tremendous losses - not as balance sheet losses, but future income losses.  All that future interest income from all those debt slaves: wiped out in an instant.  No more 29% credit card debt.  It would all be repaid.  Bank credit lent at interest would largely be wiped off the map, replaced by fiat money created by Steve Keen running the Fed.

Corporate bond debt would remain in place, so would the sovereign debt.

Like FDR's one-shot gold devaluation, it would immediately reflate the economy and remove the personal debt burden at the same time.  Prices would probably jump higher.  How much?  I have no idea.  Likely, economic activity would explode.  Not hyperinflationarily, but with $50k in fresh money in hand, a whole bunch of low-debt poor people would likely go on a shopping spree…"I want a brand new car."

Not saying that particular aspect is a good thing, mind you.  But the debt paydown - that's the part I like.

Anyhow, that's his concept.

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St.Steve has a post on Forbes about the stocks and flows.
http://www.forbes.com/sites/stevekeen/2015/03/30/the-principal-and-interest-on-debt-myth-2/

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I get the argument hat Steve Keen makes in his "debt money isn't by design exponential" but it's flat out wrong from a real world perspective.
First, we have the empirical evidence which shows a 0.99 R^2 for an exponential curve fit a credit growth in the US over the past 60 years.  If one want's to argue that such a system is not inherently exponential by design, then one has a rather steep hill to climb.

Second, the way in which Steve chooses to model the system works out as not being exponential by design because he has perfect stocks and flows modeled in.  Every stock is offset by perfect flows all matched by the perfect spending of interest income within the exact same groups that first borrowed the money from the banks.

However, once you have imperfect stocks and flows then things rapidly go out of balance and towards exponential behavior.

Consider a simple system where just one wealthy industrialist accumulates all the flows for one year, lends them all out again as debt, and then cannot even begin to spend all of his interest 'earnings' each year.  Now the interest earnings are not cycling around and as this industrialist lends out even the excess interest earnings they are compounding the problem.

With any sort of accumulation and stagnation in the system it tends towards exponential increase and this is what we both actually and expect to see in the real world.  

As bad as assuming perfectly rational actors is the assumption of perfect stocks and flows.  Might as well call them immaculate stocks and flows because they'd be a miracle…