Straight Talk with Steve Keen: It's All About the Debt

"Straight Talk" features thinking from notable minds the audience has indicated it wants to learn more about. Readers submit the questions they want addressed and our guests take their best crack at answering.

This week's Straight Talk contributor is Steve Keen, Associate Professor of Economics & Finance at the University of Western Sydney and author of the popular book Debunking Economics and the website Steve Keen's Debtwatch.  Steve's research focuses on the dynamics of debt and leads him to believe that debt-deflation is the key issue that will continue to dictate what happens in the global economy.

 1. Much of your research is complex. Can you summarize some of the more important conclusions of your work in ‘layman's’ terms for us?



Steve: Sure. My work is complex in part because I reject conventional economic analysis, which has infected how ordinary people think about the world—just as the Ptolemaic view of astronomy infected people’s minds prior to the Copernican revolution. So to explain my work I have to start with where I differ from conventional “neoclassical” economists, who now are rather like Ptolemaic astronomers—who tried to understand what they see in the sky by inventing more and more “spheres” on which heavenly bodies were supposed to rotate, rather than accepting Copernicus’ far simpler model of a solar system centered on the Sun.

The key ways are that I see the economy as being credit-driven, and out of equilibrium all the time. The economy needs an expanding supply of money to grow, and in our credit-driven economy, most of that expansion is driven by rising debt.

This isn’t necessarily a bad thing: an entrepreneur with a good idea needs money to put that idea into action, but hasn’t necessarily got the money to finance it. Debt as a form of venture capital gives him that money, which therefore means he has money to spend before he has goods to sell to finance that expenditure. As a result, aggregate demand in the economy exceeds the level it would be if it was financed simply by selling existing goods and services.

This is a good thing, since otherwise innovation and growth wouldn’t necessarily occur, but it also brings a danger that debt can be used, not merely to fund entrepreneurial activity (which is a good thing), but speculation on asset prices.

It also introduces a volatile term into aggregate demand that almost all other economists—neoclassical, so-called Keynesian and even Austrian economists—ignore: aggregate demand in the economy is the sum of GDP plus the change in debt, where that aggregate demand is spent not merely on new output (goods and services) but also on purchases of existing assets (shares and property).complex, in the technical sense of the word—I have built complex dynamic mathematical models of the economy which simulate both a debt-driven boom and a debt-deleveraging-driven depression, and these guide my analysis—but the essence of my analysis can be conveyed with a simple numerical example.

Imagine a country with a nominal GDP of $1,000 billion, which is growing at 10 per cent per annum (real output is growing at 4 per cent p.a. and inflation is 6 per cent p.a.), and which has an aggregate private debt level of $1,250 billion which is growing at 20 per cent p.a.—so that private debt increases by $250 billion that year.

 Ignoring for the moment the contribution from government deficit spending, total spending in that economy for that year—on all markets, both commodities and assets—is therefore $1,250 billion. 80 per cent of this is financed by incomes (GDP) and 20 per cent is financed by increased debt.

One year later, the GDP has grown by 10 per cent to $1,100 billion, but imagine that debt stabilizes at $1,500 billion, so that the change in debt that year is zero. Then total spending in the economy is $1,100 billion, consisting of $1.1 trillion of income-financed spending and no debt-financed spending; this is $150 billion less than the previous year. Stabilization of debt levels thus causes a 12 per cent fall in nominal aggregate demand.

What about if debt doesn't actually stabilize, but instead grows at the same rate as GDP? Then we get the following situation: in the first year, total demand is $1,250 billion, consisting of $1,000 billion in income and $250 billion in increased debt; in the second year, total demand is also $1,250 billion, consisting of $1,100 billion in income and $150 billion in increased debt. Nominal aggregate demand is therefore constant, but after inflation, real aggregate demand has contracted by 6 per cent.

There are thus three ways in which debt affects economic activity: by its level, its growth rate, and whether its growth rate is rising or falling. As this numerical example illustrates, the economy can suffer a recession simply if the rate of growth of debt slows down—absolute deleveraging isn’t required to have a recession, but deleveraging is what turns a garden variety recession into a Depression.

These three factors—the level, rate of change, and acceleration rate of debt—are easily shown to be the driving forces in “The Great Recession”. They’re shown together on the chart below (the graphs don’t quite line up because the velocity and acceleration are measured with a one year lag):

Think about them in terms of driving, where distance, velocity and acceleration determine how the journey will go.

The level is like distance: the further apart two places are, the longer the journey will be at any given speed. A small debt to GDP ratio is like a short drive—you rarely worry about it—but a large ratio is like a very long drive. In that sense, America has a long way to go to get back to where it was before growth in the shadow banking system turned its economy into a disguised Ponzi Scheme. Debt would have to be reduced by the equivalent of two full years of present-day GDP. That’s an enormous amount of deleveraging.

The rate of change is like velocity: it tells you how fast you’re travelling towards your destination, and the impact of that velocity on the economy is a bit like the thrill of driving quickly versus moving slowly. The velocity of the USA’s increase in debt was rising right from the end of WWII till the end of 2006. When it was fast, it felt like racing between cities—and unemployment fell as a result. When it was slow, it felt like being stuck in an LA traffic jam—and unemployment rose. Now that it’s negative (for the first time since the Great Depression) it feels like you’re rolling backwards very quickly—and unemployment has exploded.

However unemployment has stabilized recently because of the third aspect of debt: its acceleration, which is like acceleration in driving speed too: put your foot down and you’ll feel the pleasurable G-forces from moving more quickly; slam on the brakes and you’re body will push against the constraints of the seat belt (if you’re wearing one).

The trick here is that, since aggregate demand is the sum of GDP plus the change in debt, the change in aggregate demand is the sum of the change in GDP plus the acceleration in debt. Since the change in aggregate demand determines the change in employment, it’s possible for employment to get a boost merely if the rate of deleveraging declines: so reducing debt more slowly will actually stimulate demand.

This is what has happened recently, as my next chart shows (again with a lag since I’m graphing the acceleration in debt from a year ago against unemployment now). Because the rate of deleveraging has slowed down recently—and largely under the impact of government policy which is trying to encourage lending (as well as undertaking its own public-debt-financed spending)—that feeling of rolling backwards is slowing down and making us panic less.

However there’s a limit to this feel-good factor: for the deceleration in deleveraging to continue, at some point America would need to start re-leveraging again—to increase debt faster than GDP once more. That was feasible when debt levels were smaller—like back in the 1970s when debt first exceeded 100% of GDP. Now that it’s almost 300%, all sectors of the economy are “maxed out” and it’s highly unlikely that any can be enticed into increasing their leverage.

The days of the Ponzi Economy are finally over. The only sector of the economy that now has the capacity to expand its debt level is the government, which brings me to your next question. 

2. Your position is that deflation is the more likely outcome for major global economies because the amount of private debt that needs to be written-off/deleveraged dwarfs any money-printing central banks will be able to do. True? And if so, how do you see things playing out from here?



Steve: Yes that’s true, but I have to admit that the scale of government spending to fight this crisis—as well as the willingness of politicians to restart some of the irresponsible private sector behaviors that caused the crisis in the first place—took me by surprise.

On reflection, I shouldn’t have been so surprised, because politicians and their conventional “neoclassical” economic advisers were rather like the captain and crew of the Titanic, confidently driving the ship full throttle in the belief that there weren’t any icebergs in the North Atlantic. When they finally saw one, they went from confident complacency to sheer panic, and threw every economic principle that they had previously sworn by out the proverbial window.

Ironically, those “principles” told them that fiscal policy couldn’t boost aggregate demand, and that the economy could be fine-tuned by small adjustments to interest rates. But in panic they hit their economies with the biggest fiscal stimuli in human history, and drove interest rates as low as they could go.

The outcome is that they have managed to slow down the rate of deleveraging compared to what it would have been without their interventions—and this has stabilized the downturn to some degree in the USA.

However the rate of private sector deleveraging—particularly by the shadow banking sector, which was largely responsible for the crisis in the first place—has still been so great that government action hasn’t prevented deleveraging, even when government debt-financed spending is taken into account. But the government’s policies have managed to slow down the rate of deleveraging, and this is what has temporarily stabilized unemployment.

If governments kept this level of spending up, then they could possibly cause an outcome like Japan since its Bubble Economy burst back in 1990: where rising levels of government debt neutralized the depressing impact of excessive private debt. This would imply a sustained period of stagnation rather than growth, and I don’t think this would be politically sustainable in the West.

However what’s more likely now is a return to the previous ideology that governments should at worst balance their budgets, and preferably run surpluses—this is certainly the bias in the UK’s recent political shift, as well as in the recent Republican revival in the USA. These policies would withdraw publicly financed spending power from their economies without enabling its replacement by private credit financed spending. Private sector deleveraging would restart and we would fall back into recession/Depression.

This will cause a rise in unemployment again, and strong political fallout this time too since incumbent politicians would be directly responsible for it. I would expect a renewal of the stock market falls of 2008 if this happened, and a renewal of the gold bubble.

The one country that has apparently avoided the crisis so far is my home country, Australia. This isn’t because it behaved differently prior to the crisis, but because government policy halted private sector deleveraging in late 2009, and since then private debt has grown and continued to boost aggregate demand.

Thanks to this—and Australia’s favorable position relative to China—Australia’s unemployment level peaked at 5.8% and has since fallen to 5.1%--virtually half the US rate.

The only reason that Australia succeeded in stopping deleveraging was that it encouraged the household sector back into speculating on house prices via what it called the “First Home Owners Boost”—in which an already generous A$7,000 government subsidy to first home buyers was doubled (and trebled for those buying newly built homes). If they hadn’t done this, then Australia would have experienced deleveraging as did the USA, and its unemployment rate would be substantially higher than it is now, because aggregate demand in Australia would have been about $100 billion lower.

The roughly A$4 billion that the government threw into the scheme was turned into about $100 billion of extra borrowed money in the economy via a double-leverage process: first home buyers used leverage from the banks to pay an additional (say) $40,000 for their first purchase; the vendor then took the additional $40,000 and levered that up to an additional $200,000 (say) on their next purchase.

The end result was that mortgage debt, which was on track to fall to about 79% of GDP by mid-2010, instead rose to 87%--an 8% turnaround in debt-financed spending.

This renewed the speculative bubble that had already made Australian house prices the most unaffordable in the world.

But hey, why complain about a Ponzi Scheme when it gives you a booming economy? Governments around the world are now trying to restart the private lending engine that had caused the crisis in the first place by financing disguised Ponzi Schemes in shares and property.

Finally, there should be no mistaking that the USA is in a Depression. While the headline U-3 unemployment rate is a “mere” 9.6%, the more realistic U-6 rate is 17%, and Shadowstats alleges that the real rate is 22.5% (though John Williams notes that the comparable rate in the Great Depression would have been 37%—so U-6 is therefore probably a comparable measure to unemployment in the 1930s). Either of the last two rates is clearly in Depression territory.

The level of private debt is 1.7 times what it was back in the 1930s, which implies that the deleveraging pressure will last much longer than it did back then; on the other hand, the larger government sector and it rapid response to this crisis works in the opposite direction. This however implies a Japanese-like outcome: decades of sub-par growth. I expect instead that the other major forces of our time—Peak Oil and Global Warming—will kick in and force significant changes in human behavior long before the politicians confront the financial sector. 

3. What is your rebuttal to the (hyper) inflationists? What data would you need to see to reconsider your position? Does the recent news and market reaction to QE2 affirm or challenge your position?



Steve: The hyper-inflationists basically argue that government money creation will cause hyper-inflation. In this I think they’re unwittingly relying on the “Money Multiplier” model of money creation: the government prints $10, a depositor puts this in a bank account, the bank hangs onto $1 and lends out the other $9, which is deposited in another bank, and so on. Over time you turn $1 of government money into $10 total, which drives up demand for goods and services and causes inflation.

The Central Banks themselves are relying on the same model—especially Bernanke with QE1 and now QE2. So if the model actually worked, both Central Banks and the hyper-inflationists would be right: inflation would result and our current debt-deflationary crisis would become an inflationary one. The only difference is that the Central Banks think they can control and moderate the rate of inflation, and the hyper-inflationists think it will be a runaway process.

The trouble is, as I showed in the “Roving Cavaliers of Credit” post, is that this “deposits create loans” model isn’t how credit money is actually created. Instead, as good empirical work by Basil Moore and other Post Keynesians (and even staunch neoclassicals like Kydland and Prescott) has confirmed, “loans create deposits”, and government money creation largely follows credit money creation, rather than the other way around.

Ironically, this fallacy gives the hyper-inflationists and the Central Bankers—in particular Bernanke—something in common: they both appear to believe that Central Banks can cause inflation easily, and that the Great Depression was the fault of the US Central Bank. Bernanke goes to great lengths to assert this in his Essays on the Great Depression, and even famously remarked to Milton Friedman and Anna Schwartz at Friedman’s 90th birthday party that:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again”

His main evidence was the collapse of M1 under the Fed in the 1930s, which he said turned a mild downturn into the Great Recession, and on Friedman’s data, this did indeed happen.

But if you take a look at the St Louis FRED series for M0, you can see that this collapse in M1 occurred even though the Fed at the time was boosting M0.

So Bernanke was wrong: the Fed did try to cause inflation during the Great Depression—it just didn’t work. M1 fell even though M0 increased because private sector deleveraging and the consequent reduction in the money supply swamped the Fed’s attempt to boost the money supply via increasing M0.

The upshot of this for the inflation-deflation debate is twofold. Firstly, an injection of government money will not cause a boost in credit money creation—especially in the world we live in now with such excessive levels of private debt. Secondly, Central Banks will underestimate the amount of money they need to inject to actually cause substantial inflation—and they’ll probably give it to the wrong groups as well (bankers rather than debtors) in the false belief that this will give them more “bang for their buck”.

These results are apparent in Bernanke’s first attempt to right the ship of state, QE1 (as it now has to be called) when he doubled base money in just 4 months. To give him some credit here, this was a far larger attempt to stop deflation than his predecessors attempted—and to more than take that credit away, he was also complicit in ignoring (and in fact promoting) a far larger runup in private debt prior to the crisis, which was the real cause of the Great Recession.

QE1 did cause some inflation, but very little compared to what I think Bernanke expected, and it’s already turned back towards deflation.

I also have my own dynamic modeling of inflation, which relates it to four factors: changes in money wages, the level that firms markup their monetary costs of production, the money stock and its rate of turnover. The hyper-inflationists focus only on the third issue—the money stock and in particular its rate of growth. During a Depression, falls in money wages, falls in firm markups, and a reduction in the rate of turnover of the money stock can easily counter growth in the money stock—especially when the privately created component of the money supply is also falling.

So it would take an enormous injection of base money to turn these other factors around. If Bernanke was contemplating not a mere $600 billion in QE2 but say $6 trillion in QE3, then I might expect deflation to give way to inflation. And if they gave the money in QE3 to the debtors rather than to the banks, then there would also be more inflation. But I think both those outcomes are highly unlikely. 

4. Related to the forecast you provided in question 2, what should we (governments, corporations, individuals) be doing right now to restore fiscal “soundness”?



Steve: This is a tricky one for a very simple reason: if my preferred remedies were enacted now, they would be blamed for causing an ensuing crisis, when in fact all they would do is make the existing crisis more obvious.

I make the analogy between my situation and that of a doctor who has as a patient a comatose mountaineer who climbed too high without sufficient insulation and now has gangrene. If you operate before he regains consciousness, he might only lose a foot, but he’ll blame you for making him a cripple. If you wait till he regains consciousness and sees what the alternative might be, he’ll thank you for saving his life when you remove his leg.

America in particular—but also much of the OECD—has substituted essentially unproductive Ponzi speculation for real productivity growth in the last 4 decades, which the rising debt bubble has obscured as it simultaneously allowed Americans to live the high life by buying goods produced elsewhere using borrowed money. There’s no way to come to terms with that without suffering a substantial fall in actual incomes.

I’d prefer to come to terms with these realities rapidly rather than slowly, but the political reality is, as Winston Churchill once put it, that “The United States invariably does the right thing, after having exhausted every other alternative”. So I’m proposing changes that I know are only feasible after several more years of failed conventional policies have been tried. I also realize that most of these ideas are well outside not just the mainstream, but many of the positions put by non-mainstream critics as well.

The basic list is:

  • Abolish Ponzi debts, which are those that have been used primarily to drive up asset prices rather than finance investment or consumption. This includes most shadow banking system debt (about 100% of GDP), much of the runup in household debt since 1985 (when it was about 50% of GDP), and probably most of the 30% increase in business debt beyond the 50% level that applied in the 1970s.
  • Since the first move would bankrupt the financial sector (or rather convert it’s state of de facto bankruptcy after the crisis—without the government bailouts—into de jure bankruptcy) banks should be put into temporary nationally administered receivership, during which time the flow of working capital to firms would be maintained.
  • Reform financial assets to prevent future debt-funded Ponzi bubbles. As I explain in the Roving Cavaliers of Credit, I don’t think it’s possible to stop banks wanting to lend too much money, so I’d rather reduce the attractiveness of debt for Ponzi speculation itself by making it much less likely that profits could be made from leveraged speculation.
  • Finance infrastructural development with fiat-money financed government deficit spending as recommended by the American Monetary Institute. I don’t accept the position put by so-called Chartalist economists that government spending can overcome any recession, but we live in a mixed credit-fiat money economy, and just as private sector money should grow when the economy grows, so should fiat money. The failure of the government to do this under the influence of Friedmanite ideas about money was a contributing factor in the explosion of debt-financed money and the financial crisis. It caused a rundown in the quality of US infrastructure, and I defy anyone to argue that government spending could be any more wasteful than what the private sector did with its monetary growth. Especially in a period where private investment is likely to be subdued, there’s a good reason for government spending on infrastructure to lead the way to revived expectations.

5. You have a front row seat to the rise of the Asian economy from your home in Australia. If/when, the US defaults on its debt obligations (either through devaluation of the currency or pure default), what specific steps do you see China and Japan taking to protect their interests?



Steve: China is already doing it: China undertook a deliberate program of industrialization via the relocation of production by western multinational corporations from America (and elsewhere), and unlike much of the Third World, required these foreign companies to take on local partners and transfer ownership of much of the capital over time to Chinese nationals. So they won the War of Industrialization in the last 3 decades, while the West lost. That industrialization was primarily directed at export sales that were debt-financed; now that they are drying up, China is hanging on to the capital and expertise it has accumulated, and redirecting production as fast as it can towards domestic demand.

They are also moving out of the US dollar and US bonds into commodities, and trying to buy up direct ownership of resources worldwide with the US dollar purchasing power they accumulated via their trade surpluses. So by the time any default comes—or more likely before the devaluation of the US dollar becomes extreme—they will have transferred their monetary assets into real ones.

Japan is likely to be far less assertive in its moves. It’s likely to hang on to the bonds as the US dollar depreciates, though unwinding of private holdings of US financial assets is likely to amplify the downward trend in the dollar. 

6. What are your views on Peak Oil? Specifically, when do you forecast the market will recognize its significance? What do you see as its impact on the economic growth of developing nations?



Steve: I regard Peak Oil and Global Warming as far greater challenges to our species than the financial crisis—which I refer to sometimes as Peak Debt. It amazes me that awareness of Peak Oil is as limited as it is, when the evidence is quite compelling and the basic concepts quite straightforward. The fact that the USA became besotted with SUVs during the SubPrime Boom is just another indicator of how lacking in foresight the human species seems to be—despite our incredible intelligence.

The financial market will likely react to it five or ten years after we’ve passed the Peak, and the physical market—the means of transportation we still buy, the way we generate energy—is over 30 years too late in reacting. We should ha

This is a companion discussion topic for the original entry at

Kudos to Dr. Martenson and the staff for this interview!  I am so pleased this has been published on CM. com.
Dr. Keen’s work (as well as other Post Keynesian economists) is a bright spot in a very dark landscape, his approach to the crisis and non ideological suggestions for reform are refreshing and succinct at the same time.

What a great and thorough response to your questions by Mr. Keen.  Thank you Steve!  We are in your debt, er, so to speak.
To start the conversation, I hold a different view of the roots of hyperinflation.  From the above article:

Steve: The hyper-inflationists basically argue that government money creation will cause hyper-inflation. In this I think they’re unwittingly relying on the “Money Multiplier” model of money creation: the government prints $10, a depositor puts this in a bank account, the bank hangs onto $1 and lends out the other $9, which is deposited in another bank, and so on. Over time you turn $1 of government money into $10 total, which drives up demand for goods and services and causes inflation.
I happen to agree that demand-driven inflation has little chance of erupting anytime soon.  Yet how do we make sense, then, of charts like this?

Note that over the past year stocks, bonds, and commodities are all up, and quite powerfully.

One way to make sense of this behavior is to note that inflation is not a purely monetary phenomenon, although that is one of the more important variables.  To be complete, we should list out all the variables:

  • Amount of base money
  • Net credit creation/(destruction)
  • Demand for money
  • Demand for goods & services
It is that third one, demand for money, that I think is driving the rise in all asset classes.  Specifically a reduced demand for dollars.  While inflation may be a demand driven event, hyperinflation derives its fuel from a loss of faith in the currency itself (a point recently made by Gonzalo Lira that we've been discussing in the enrolled section).

Is it possible for hyperinflation to happen even as aggregate capacity utilization is falling?  Sure, just check out Zimbabwe between 2000 and 2008.  Inflation practically set a modern record and capacity utilization was at 10% by the end of it all.

With several trillions of dollars of outstanding currency claims, the US dollar could certainly experience quite a tumble and we could see rapidly escalating prices as a consequence, even as aggregate demand crumbles due to a lack of affordability by average people whose incomes are lagging a lightening fast adjustment (by comparison). 

This argument does not depend on the money multiplier at all.  I think keeping a close eye on the money multiplier is a good idea because the odds are that the loss-of-faith event will not happen (they are historically rare) but at the same time it might be prudent, especially in the world of QE II and such, to at least have one eye open to the possibility of the unusual occurring.  

We live in unusual times.

Hi Chris,
I hope your trip to Scotland was fruitful for you and them.

There were great questions to Steve.

I would assume that as the commodities asset class continues to outdo both the stock market and the dollar, we wil continue to see speculators and hedgies piling in, to all of our detriment. It seems like that will accelerate the decline in the ability of the non-wealthy to meet their basic needs here in the U.S.



This is certainly a step in the right direction - an economic theory that recognizes bubbles before they burst.

It seems that the third factor is intimately related to the second (net credit creation) in a credit-money system. As Dr. Keen stated, it seems that the government injection of liquidity via bailouts, stimulus and QE has served to decelerate the rate of credit destruction, stabilizing employment and artificially reducing the demand for dollars. However, once this rate begins accelerating again, there will be a huge pickup in demand for dollars by still heavily indebted consumers, investors and businesses, and also fiscally troubled states/localities.

I also think that GL overestimates the likelihood that a temporary spike in commodity prices (either due to excess liquidity or some geopolitical event) will lead to a complete loss of faith in the dollar, when debt levels and unemployment is still so high.

The material is quite dense, but I’ve read a good bit of Dr. Keens’ work so I’ve seen much of this before. In the interest of stimulating some discourse around this, and at the risk of thoroughly embarrassing myself (by poorly interpreting a complex subject) I’d like to put forth a more condensed version of what I’ve gleaned from Dr Keens’ work, which includes some (but not all) of the points on this interview.
The Post Keynesian perspective, from which Dr. Keen takes his primary economic direction, contains many interesting rebuttals of neo-classical economics, and goes quite a distance to explain not only the fallacy of monetary theory, but goes on to identify poorly formed assumptions that are scaled into the macro-economic world leading to some rather large mistakes in critical thinking. So what does all his mean to us mere mortals? Maybe quite a bit. Here is my layman’s summary:

1.)   The study of monetary theory, and the answer to the age old question (asked and answered by Marx) of “Is it possible for a capitalist to make money from borrowed money” or, as posited on this forum, “Is debt based currency intrinsically destined to failure”, cannot be answered (correctly) using simplified static methods, dynamic (time domain based) techniques and equations must be used if a useful answer is expected.

2.)   Using such methods, he demonstrates numerically that debt based currency systems can be (but usually are not) stable, and stable at the macro-economic scale for large amounts of money, not just with trivial test cases.

3.)   The reason that such systems are “usually not stable” is that inevitably, speculative and Ponzi style investment practices are present in large economies (such as in the US ) and these practices are inherently and catastrophically destabilizing.

4.)   Speculative and Ponzi investment schemes are prevalent in part due to factors identified in Minsky’s Instability Theory, which characterizes an investment culture that overreaches due to easy profits and improper risk assessment, leading to a cascading series of ever more risky investments.

5.)   As a result of this research, Dr Keen advocates a reform type approach to monetary policy, addressing containment of the Ponzi type investment schemes, and not a wholesale abandonment of the current debt based system. He goes on to say that it is likely that Peak Oil and other associated issues will likely intervene before this becomes realistic.

6.)   Keynesian type stimulus efforts wherein banks are the primary recipients of stimulus funds are inherently unsuccessful, due to the so called “capital strike” or more conventionally, the “liquidity trap”.

7.)   Kensysians type stimulus efforts wherein debtors are the primary recipients of stimulus monies are more successful, but can be inflationary.


Additionally, there is some work on his website that comments on the overall subject of globalization, which seems to present in a similar fashion of “debunking”, wherein mainstream concepts such as comparative advantage as advanced by Ricardo, are revisited with some rather different conclusions, namely that these practices not only result in significant unequal wealth distributions, but are in fact designed to do just this.

Taken as a whole, these findings to me anyway, illustrate a very different political reality than seen in mainstream American politics, and when fully processed and vetted, indicate a socio-political direction quite different from what is considered normal. Taken to heart, these findings could well be the genesis of a new political party, with a platform based on an intelligent and rational understanding of money, prudent and effective regulatory input, and perhaps most importantly, the how’s and why’s of unequal income distributions.

Well, at least until we run out of oil.

Great Q&A. Though I am familiar with Dr. Keen’s work, I still learned a great deal from this article. Thanks to Dr. Keen and Adam for providing this excellent content.


With respect Dr. M, I think you are putting the cart before the horse with this argument. The speculation that is occurring in commodities is not a reaction to a depreciating dollar, it’s the cause of the depreciating dollar. And like all market (or Ponzi) strategies, it will exhaust itself like it has so many times in the past. The problem is, the cash pool to settle these trades is shrinking with the economy, thus this speculation will ultimately lead to sequentially higher dollar demand, not reduced demand. 

Awesome.  An economist who is respected on this site has finally said it.  Perhaps it will no longer be attacked as quackery. As Steve suggests, the lack of this was a contributing factor to hyperleverage, i.e. unsustainable ponzi math, in the first place.  I don’t care who gets the credit.  I just want the US to do this.  And if the US doesn’t since it’s held hostage, then I hope the states assert their sovereign powers to put pressure on the system to do it.

Again, very gratifying to see a respected economist challenge this remaining legacy of conventional wisdom.  If non-ponzi money isn’t injected into the system (tied to supply-side infrastructure…the very definition of value), then ponzi math can’t be avoided.

Hi Chris,
I’d see three main sources of these blowouts: a speculative run from the currency as you suggest; the direction of most of the QE money into speculation as well; and the inevitable decline the of the US dollar, whose value has only been kept up by its reserve currency role in the global economy as it has run a Ponzi Scheme for the last 30 years.

This has given us inflation in commodity prices as people have moved out of speculative holdings of financial assets into speculative holdings of commodities. Whether this will then mean that the price of final consumption items rise–which I treat as the proper definition of inflation–is a moot point. I expect that the pressure on producers and retailers will mean that they can’t pass on much of this speculative-driven increase in commodity costs, and this may ultimately prick these commodity price bubbles at some point in the future.


[quote=Keen] Finance infrastructural development with fiat-money financed government deficit spending [/quote]
I’m assuming he primarily means alternative energy infrastructure and/or mass transit projects.

Why Obama can’t propose to devote $50B towards wind/solar farms instead of repairing existing roads/highways is beyond me. Of course, it would be much better if it was pure fiat-money instead of credit-money, but that’s asking too much from TPTB.

According to this stimulus package break-down from the WSJ, close to $51B is allocated to “Energy and the environment”


Yeah I’m glad they at least got that into the first stimulus, but I was referring to his new stimulus proposal that includes $50B in infrastructure spending:


Mr. Obama is proposing a $50 billion plan as an initial step toward a six-year program of transportation programs. It calls for building, fixing or maintaining thousands of miles of roads, rail lines and airport runways, along with installing a new air navigation system to reduce travel delays, and other projects. [/quote]

Thanks for the great Q&A.

Michael Hudson

I love Steve Keen… have read his stuff for quite some time… but I find the entire Q&A quite unsatisying… I don’t think you can model out what is coming… there is not basis for modelling the situation we are in.  I don’t have the answers either… but I do know that the following questions were not answered;
1)  What happens if the rest of the world loses faith in the dollar before the somnambulent Americans do?  These dollars will flood in somehow and we won’t be facing quite the deflationary dollar shortage described here.  Am I wrong?  Why?

2)  The “solutions” posed posit a backdrop of reasonably normal markets… but, WE ARE NOW BUYING ALMOST ALL OF OUR OWN DEBT GOING FORWARD.  That may not be a problem for now… but there will be no turning back to normality after that.  How high will interest rates need to be before you restart exogenous demand?  It is this step function change in interest rates that Gonzaro posits will drive a mass selling of treasuries, with that money ending up in real assets (hyperinflation).  How do we end QE without inciting hyperinflation?  

We don’t… that’s the answer… maybe we back off in stages… from 75% of all debt … down to 50% for a year… then down to 40%…  before we could ever pull out… the system will die.  

My personal feeling is that even this conversation with Keen is just a bunch of elegant claptrap.  Maybe I just need some prozac at this point.  



Steve,  Thank you for the reply.  This is quite a treat.

You know, I have to admit, this commodity run feels like a blowout.  

I mean, good grief(!), look at this thing!

I can certainly see how the case can be made for this being just another speculative frenzy built on the back of fraudulent money printing and expectations by market participants for more of the same.  

Perhaps it will soon be overwhelmed by deflationary forces that will crush these prices right back into the ground?

But when I widen up my view a little bit, say back about ten years, I suddenly get the feeling that even if we are in a period of frothy excesses, those happen to be riding on the a decade long trendline that has a slope equivalent to a double digit rate of inflation (over 12% for the line, over 15% if we draw the line up to the new peak).

I concur completely with your assessment that unless the two 'flations transmit themselves to final prices they are not really worth the effort of debate and analysis.  

My question is this…how long is necessary before we can reasonably claim that the trend is inflationary or deflationary?  I look at this chart and come to the conclusion that we are locked in a decade-long and quite serious bout of commodity inflation.  To me, this looks and feels like “final transmission to prices.” By this measure the CCI could fall all the way back to 500 or so and not violate the trendline.  That’s a long ways down from here.

If we breach the 2008 highs, (which has already happened in euro terms) and accelerate from there then we might conclude that we are entering “stage II” of the inflationary process (defined more by the loss of faith in money than an excess of money). 

From this vantage point I think I see a perfect storm of colliding factors; loss of faith in an abused reserve currency, structural demand arising strongly from late entrants to the game of consumer-led consumption (China, India, Brazil, et al.), and looming supply issues with respect to peak oil.  Taken together, the normal “steady state” analysis of how things should work might need to widen out and include the possibility that in this complex system there might be a few emergent properties or two that we’ve not yet encountered in the past.  

Among those, I remain most concerned about a chaotic retreat from the dollar and the various knock-on impacts that would then ripple through an as yet unmodeled and untested derivatives market with a nominal value now most easily expressed using the term “quadrillion” but whose complexity defies description.    How a global, fiber-optically connected financial system will behave during a derivatives “repricing event” is, again, unpredictable and unknowable.

As with everyone who is paying attention in these interesting times, I have only my observations, many questions, and an almost unbearable certainty that whatever happens next is going to surprise me.  I truly appreciate your efforts to help shed light on a very complicated situation.

The commodity inflation has to go somewhere… and to the degree it is not transmitting directly to final price, Denninger has it right - it is going to cause margin compression, meaning earnings compression, meaning stocks don’t look so good anymore… more leaks in the “wealth effect” damn… the FED is going to run out of fingers.

This is a great conversation.  Way to go Adam.


Steve: I regard Peak Oil and Global Warming as far greater challenges to our species than the financial crisis—which I refer to sometimes as Peak Debt. It amazes me that awareness of Peak Oil is as limited as it is, when the evidence is quite compelling and the basic concepts quite straightforward. The fact that the USA became besotted with SUVs during the SubPrime Boom is just another indicator of how lacking in foresight the human species seems to be—despite our incredible intelligence.[/quote]

I was delighted to see Steve’s comment on global warming as well as peak oil.  Of course the latter is virtually unknown to the general public and the former has been the victim of the campaign to discredit by inuendo and blatant falsehood.  But, nonetheless climate change remains a looming threat and needs to be discussed in the same conversations as peak oil since they are so linked.

I would be interested to hear Steve’s thoughts on climate change and its relationship to the three Es.