Monday, March 12, 2012

350 Privatization of the money power is an "original sin" of our system

Privatization of the money power is an "original sin" of our system

Stephen Zarlenga (item 1) would turn the Banks into Building Societies - allowing them to only lend out money that's been deposited with them, rather than create multiples of it (look up: Deposit Multiplier) - and have Governments creating the money, devoting it to infrastructure and national projects - the public interest, not private interest.

I am strongly sympathetic. But it's a radical measure - perhaps too much so for most people - so Ellen Brown's solution, which has Government banks operating alongside private ones - is also worth considering. Both should be on the table.

For Steve Keen's articles, visit the links to see the charts.

(1) Privatization of the money power is an "original sin" of our system
(2) Naked Capitalism and My Scary Minsky Model - Steve Keen
(3) Steve Keen & Michael Hudson to attend AMI conference (organized by Stephen Zarlenga)
(4) State Governments in Deficit Crisis, by Robert Poteat
(5) Australia's 'get out of the GFC free' card? - Steve Keen
(6) Deleveraging returns - Steve Keen

(1) Privatization of the money power is an "original sin" of our system

From: AMI <ami@taconic.net> Date: 06.07.2010 12:28 AM Subject: July 4th 2010 MESSAGE from the AMI

Dear Friends of the American Monetary Institute,

Hopefully you've celebrated this July 4th Independence Day in good style. AMI people went to Chicago's Oak Street Beach. We kept an upbeat attitude, despite the serious problems our nation faces.

We remembered the importance to peoples around the earth, of our forefathers declaring independence from old world tyranny. We inspired a revolution in France. Later, thanks to France's gift, our Statue of Liberty served as a beacon inviting peoples to our shores; including my parents and grand parents from Italy. They achieved the American Dream - owning a home and educating their kids.

Our Constitution and Bill of Rights provided some safeguards and checks and balances that held anti-democratic and anti-human forces at bay, and separated government from religion, the misuse of which had caused so much pain in the old world. But unfortunately, because the founders as a group did not understand the nature of money, they allowed corrupt monetary beliefs and practices of the old world to gain a foothold on our shores, starting with the establishment of the privately owned 1st Bank of the U.S. in 1791 (detailed in Ch. 15 of The Lost Science of Money book). As with all major banking legislation here, fraud was involved.

This privatization of the money power is an "original sin" of our system, from which most of our social problems arise. Though the Constitution expressly forbade the establishment of an Aristocracy here, my neighbor President Martin Van Buren would write “The MONEY POWER (he always capitalized it)... when firmly established, was destined to become the only kind of an Aristocracy that could exist in our political system.” That aristocracy, through concentration of wealth and power and various financial tricks, is in the process of destroying the checks and balances which had offered protection. Witness the recent Supreme Court ruling allowing corporations to finance and thereby control elections.

Economists willingly embraced the pernicious errors allowing the financial establishment to control our nation, by confusing credit for money. WHY? Salaries and position, and tenure:
“What makes all doctrines plain and clear? About two hundred pounds a year. And that which was proved true before, proved false again? Two hundred more.” - Samuel Butler’s Hudibras on Economics said it all.

Clearly, "economics" is a failed profession, with rare and sometimes great individual exceptions. Indeed, Jamie Galbraith in testimony before the Senate Judicial Committee, Subcommittee on Crime, recently wrote: "I write you as a member of a disgraced profession" and he suggested they put the fear of Congress into the financial operators who brought down the world economy. But in general, economists focusing on theoretical, mathematically dominated thinking, ignoring factual results, are unable to make course corrections to public policy. And too many Congressmen, including the financial committees leadership, were too close to the economic wreckers to propose real reform.

The financial "reforms" they are arguing over now do not fundamentally address the main problem - a privatized money system based on using private credit instead of government money. This special privilege always leads to an obscene concentration of wealth, which then can overcome the regulations.

Thus at the recent meeting of G20 countries, they proposed a double-whammy to kick the World's economies while they're down, calling for "fiscal consolidation" and 're-capitalization' of banks. Both would have the effect of putting less money into the economy while taking more money out of the economy - and they're so deluded, they claim to be expecting 'growth' to come from these conditions of monetary drought and deflation. Along with that recurring delusion, we see the ongoing illusion that the 'remedy' for debt-ridden citizens, businesses and governments is to load them up with more debt(!) We say "deluded" as the only other explanation would be that they're deliberately trying to collapse the economies.

NEW ITEMS AT THE AMI WEBSITE

The American Monetary Act (attached) is legislation which fundamentally reforms the private CREDIT system now wrecking our nation, replacing it with a government MONEY system. The act is in the final stages of development. We suggest you especially read through the "Findings" and "Purposes" section again at the beginning of the Act.

Summarizing how the Act achieves its purposes:
The Federal Reserve becomes incorporated into the U.S. Treasury. Banks no longer have the accounting privilege of creating our money supply. All their previously issued credit is converted into U.S. Money through an elegant and gentle accounting change, which has been described as brilliant by a former officer of the NY Fed. The banks are held accountable for this conversion. New money is then introduced by the government spending it into circulation for infrastructure, starting with the $2.2 trillion the engineers tell us is needed to properly maintain our infrastructure over the next 5 years. Infrastructure will include the necessary human infrastructure of health care and education.

Banks are encouraged to continue lending as profit making companies, but are no longer allowed to create our money supply through their loan making activity.

Thus, The American Monetary Act nationalizes the money system, not the banking system. Banking is absolutely not a proper function of government, but providing the nation’s money supply is a key function of government. No one else can do it properly. Talk of nationalizing the banking business may really act like a poison pill or diversion to block real reform.MORE BLOG ARTICLES AND REVIEWS OF CURRENT WORKS AND IDEAS ON MONEY ...

Stephen Zarlenga

(2) Naked Capitalism and My Scary Minsky Model - Steve Keen

Naked Capitalism and My Scary Minsky Model

by Steve Keen

Published in July 7th, 2010

http://www.debtdeflation.com/blogs/2010/07/07/naked-capitalism-and-my-scary-minsky-model/

I met with Yves Smith of Naked Capitalism on the weekend, at a superb Japanese restaurant that only New York locals could find (and I’ll keep its location quiet for their benefit–too much publicity could spoil a spectacular thing). Yves was kind enough to post details of my latest academic paper at her site in a post she entitled “Steve Keen’s scary Minsky model“.

Yves found the model scary, not because it revealed anything about the economy that she didn’t already know, but because it so easily reproduced the Ponzi features of the economy she knows so well.

I have yet to attempt to fit the model to data–and given its nonlinearity, that won’t be easy–but its qualitative behavior is very close to what we’ve experienced. As in the real world, a series of booms and busts give the superficial appearance of an economy entering a “Great Moderation”–just before it collapses.

The motive force driving the crash is the ratio of debt to GDP–a key feature of the real world that the mainstream economists who dominate the world’s academic university departments, Central Banks and Treasuries ignore. In the model, as in the real world, this ratio rises in a boom as businesses take on debt to finance investment and speculation, and then falls in a slump when things don’t work out in line with the euphoric expectations that developed during the boom. Cash flows during the slump don’t allow borrowers to reduce the debt to GDP ratio to the pre-boom level, but the period of relative stability after the crisis leads to expectations–and debt–taking off once more.

Ultimately, such an extreme level of debt is accumulated that debt servicing exceeds available cash flows, and a permanent slump ensues–a Depression.

There are 4 behavioural functions in the model that mimic the behaviour of the major private actors in the economy–workers, capitalists and bankers. Workers wage rises are related to the level of employment and the rate of inflation; capitalists investment and debt repayment plans are related to the rate of profit; and the willingness of banks to lend is also a function of the rate of profit.

The model is explicitly monetary–with bank accounts for workers, bankers and capitalists–and the crisis is marked by a collapse in deposits and a rise in inactive bank reserves.

The same phenomenon is evident in the data, though the sharpness of the turnaround is far greater than can be replicated by the smooth functions in my model.

There’s a lot more work to do before the model is complete–notably including the impact of a goverment sector that can add its own spending power to a depressed economy–but its basic features fulfil Minsky’s challenge:

Can “It”-a Great Depression-happen again? And if “It” can happen, why didn’t “It” occur in the [first 35] years since World War II? These are questions that naturally follow from both the historical record and the comparative success of the past thirty-five years. To answer these questions it is necessary to have an economic theory which makes great depressions one of the possible states in which our type of capitalist economy can find itself.

This is the first economic model ever that meets Minsky’s standards for realism. Its final stage emphasises a message that Michael Hudson, one of the very few others to see this crisis coming, puts very simply: “Debts that can’t be repaid, won’t be repaid”. As Americans now seem to be realising, the financial crisis has not gone away, because the debt that caused it is still there.

Having got ourselves into a debt-induced economic crisis, the only permanent way out is to reduce the debt–either directly by abolishing large slabs of it, or indirectly by inflating it away. I have very little confidence in the ability of the Federal Reserve to do the latter, while the former will take a level of political fortitude that is far beyond our current politicians.

(3) Steve Keen & Michael Hudson to attend AMI conference (organized by Stephen Zarlenga)

From: Iskandar Masih <iskandar38@hotmail.com> Date: 29.07.2010 06:25 AM From: ami@taconic.net
Subject: Last days to get AMI Conference discount

Register now to obtain the $120 discount on the 6th annual AMI Monetary Reform Conference ...

Some exciting developments are in store! As usual we'll have a top notch line-up of speakers:

Prof. Steve Keen, one of the world's best analysts of how money is created in present day monetary systems is coming in from Australia. He received the inaugural Paul Revere award for giving explicit and accurate early warnings on the collapse of the financial system. We expect Prof. Keen will clear up several misconceptions and help the meeting reach a strong consensus regarding the present money creation process, and whether it constitutes an immoral corporate activity, or is a necessary part of "Capitalism" or both!

Congressman Dennis Kucinich of Ohio, leading American Progressive Statesman and twice a Presidential Candidate, thanks to a heavy congressional schedule and election, will address the Conference by Video.

Dr. Michael Hudson, accurate predictor of the housing crash (May 2006 cover story in Harpers Magazine) will report on his work with the Latvian and other European reform. It's beyond me why anyone (especially congresspeople!) would bother listening to economists who did not see these problems coming - but they're still doing that.

Naturally, we're hoping that Prof. William Black will return this year. His presentation in 2009 created a sensation (view it at the AMI you tube site), in describing how fraud had to be involved at every level in the financial meltdown. He compared his successful efforts in charge of cleaning up the Savings and Loan scandal of the 1990s with the near complete lack of enforcement against today's financial criminals who brought down the world economy. He's a great breath of fresh air, and I'm convinced he will be asked to play a major role in cleaning up the present mess. ...

We're also very please to have back some natural leaders of the people who have helped monetary reform move forward no matter what, and will continue to do so!

Prof. Nic Tideman of Virginia Tech, formerly senior economist of the President's council of Economic Advisors, and in my view the most trustworthy of free market-oriented economists. Nic will discuss the key issue of seigniorage privilege of money creation and who should receive it ...

Michele St. Pierre, who is someone you really should get to know more of. A leading and brilliant organizer for effective political action and a leading voice for effective monetary reform. Michele really understands the importance of monetary reform and knows how to get things done at all levels. She brings together several important political elements, especially the Ron Paul supporters, who we seek closer ties with.

Robert Poteat, whose depth of understanding of monetary reform and all aspects associated with it will deliver another seminal lesson. Attached is a short (3 page) essay he wrote on the State Governments Crisis. Only the American Monetary Act (of any being discussed) is able to deliver a solution on the magnitude needed, including rescuing their pension obligations. As we've been saying consistently, efforts to have the states embrace the vicious process of "fractional reserve banking" instead of ending it, in exchange for a pittance, should be understood as diversions, at a critical moment when real reform is possible.

Dick Distelhorst, a living legend among people who really know monetary reform will present to the conference by video.

Ben Dyson, UK Monetary Reformer, who received rave reviews for his 2009 conference talk, will discuss how similar legislation has been prepared for England, and is now being promoted with advanced computer technology (easy for him, advanced for us!).

Jamie Walton, of New Zealand, leading AMI Researcher with a razor-sharp mind for monetary questions, will focus on the American Monetary Act.

Last years favorite, Will Abram is coming back to give us the full details of how Canada's excellent monetary reforms of the 1930s was de-railed and by whom!

There is a good chance, and we are very hopeful that the Act could be introduced by the time of the conference, and several speakers will discuss that, and how to help get attention and support to it.

Stephen Zarlenga, AMI Director, will speak on the process by which the AMI has reached this stage - strategies, challenges and plans.

Looking forward to seeing you here!
Stephen
Ami

(4) State Governments in Deficit Crisis, by Robert Poteat
State Governments in Deficit Crisis

by Robert Poteat

http://moneyreform.wordpress.com/2010/07/19/state-governments-in-deficit-crisis/

“States of Crisis for 46 Governments Facing Greek-Style Deficits” headlines a Bloomberg website article, June 26, 2010, by Edward Robinson, referring to states of the United States. The plight of California is one of the worst. California’s economy, if a nation, would rank ninth in the world. The United States federal government is in huge deficit, also. How can this happen in the once richest nation of the world and still rated as the world’s largest economy?

The economic conditions cannot be caused by devastating acts of nature such as drought, freezes, famine by insects, floods, hurricanes, volcanic eruption, etc. While some of these have been experienced, the United States is too large and diverse for them to cause such general havoc.

Another hypothesis is that nations follow an organic pattern. Nations emerge, prosper, age, and die. The United States, in its third century, is deeply in debt domestically with crumbling infrastructure. The U. S. has huge negative trade balances causing huge debt to foreign nations. The United States is also engaged in futile, self-destructive wars of empire. This makes a strong case for the organic hypothesis, but is there a simpler explanation such as human mismanagement?

Anyone with grade school education must know that expense cannot exceed income without incurring deficits and debt. Yet, 46 states and the United States find themselves in that condition. It does not take too much investigation to find out budgets did not anticipate economic downturn. It is irrational not to anticipate downturn because the United States has experienced economic expansions and contractions, at least 47 cycles, since its founding. To not anticipate economic cycles requires the extraordinary denial and deception of politicians.

What causes economic cycles? Ask three economists, and you will get at least four answers. I think Will James said economists know more that ain’t so than anyone.

Some flagrant errors of economists are non-scientific reasoning. They try to use “theories” to prove facts then dismiss facts that refute the “theory” as externalities. They confuse money with real wealth of natural resources. They do not understand the nature of money as a socio-political power while thinking of it merely as a medium of exchange. They assume that humans always make rational economic decisions then attempt to use mathematics to “prove” the false assumptions. They fail to understand the effects of credit used as money because credit is debt on the other side of the ledger. They fail to understand the fallacies of ever expanding markets in a finite world. They dismiss human suffering as an irrelevant, unscientific externality. They have irrational faith in The Market to mediate human exchange relations. How can we not be in a mess?

The first cause of the present economic downturn is the errant philosophy above that resulted in excessive speculation by the pirates and bandits of Wall Street and banking, a supine and oblivious Congress, ideologically blinded regulators, and decades of manufacturing deportation. Recovery is hampered by the resulting destruction of productive economy. Productive manufacturing has precipitously declined as a fraction of the total economy while financial services has proportionally grown. Financial services is well defined as gambling and loan sharking. It is not productive of human life supporting goods and services. It is the opposite as it concentrates wealth into an ever smaller fraction of the population.

Over-arching the historic instability of the United States economy is the private bank credit system whose credit is used as money. Since credit and debt is the same thing, we use debt as money. The long term effect has been exponential growth of debt in all sectors of the economy.

No greater historic mistake in United States history is the abandonment of the federal government’s Constitutional and moral mandate to promote the general welfare by conceding the power to create money to private banks. Whoever has the power to issue money has the power to direct society by directing what the money is used for. What the money has been used for is wars and pyramid schemes. (See The Lost Science of Money for more historical details.)

The American Monetary and Financial Security Act will restore the power to the federal government as established by Article I, Section 8, clause 5 of the Constitution: The Congress shall have power…. to coin Money and regulate the Value thereof, and of foreign Coin…. At the present time, the federal government restricts its revenue to taxes and borrowing. To permit banks to issue money, borrow that money, and pay interest on it has resulted in more than 13 trillions of federal debt with hundreds of billions of dollars of unnecessary interest expense, annually.

Since the Great Depression of the 1930’s, the federal government has resorted to deficit spending in attempting to correct for the recessions that are endemic in the U. S. style economy. (The endemic reasons will not be discussed here.) It was the recommendation of a noted economist, Sir John Maynard Keynes, hence it is called Keynesianism.

Keynesianism will have the desired effect if done in sufficient quantities, but borrowing money for Keynesian stimulus merely “kicks the can down the road” requiring more and more stimulus with resultant increase in debt. If the government created and spent its own money there would be no deficit and no increasing debt.

The federal government has put taxpayers at risk for trillions of dollars by “bailing out” the pirates and bandits who were mostly responsible for the present recession while applying a grossly inadequate 800 billion dollars in stimulus to the people. The banks are reported to have recovered but the economy remains depressed and public debt is increasing at an alarming and unsustainable rate. Small banks are still failing at an alarming rate.

According to the Bloomberg article, the total shortfall of states is a mere $112 billion. Not much more than pocket change compared to the “bail out” of banks and only a fraction of the stimulus.

Under the terms AMFSA all these economic shortfalls could be adequately funded without incurring debt.

(5) Australia's 'get out of the GFC free' card? - Steve Keen

From: John Craig <john.cpds@gmail.com> Date: 29.06.2010 08:56 PM

Australia's 'get out of the GFC free' card?

Steve Keen

Published 6:28 AM, 29 Jun 2010 Last update 10:16 AM, 29 Jun 2010

http://www.businessspectator.com.au/bs.nsf/Article/sovereign-debt-government-US-recession-Great-Depre-pd20100628-6U573?

One of the unexpected things I've learnt in Boston is that the global financial crisis is not called the global financial crisis in America – and therefore the TLA* of the GFC has no meaning here.

Instead, in America this might be 'The Crisis That Has No Name' (TCTHNN), because they don't call it anything at all – it's just how the economy is right now.

Australians, it seems, are the ones who invented the moniker GFC as a way of describing what they don't understand. Over here, where it is actually happening, it is just the day to day reality that must be contended with.

Even more peculiar is news from some finance sector insiders here who have been in touch with Australia's RBA, that the RBA and Treasury are starting to describe it as not the GFC, but the 'North Atlantic financial crisis' ('NAFC') – arguing once again via a label that this crisis is peculiar to the US and Europe.

Apparently when asked what Australia has learnt from the crisis, the answer was often: "Nothing, because it didn't happen here". The Lucky Country, it seems, is seen as immune to the crisis by its economic managers.

I know that I'm more likely to be spoken to by Bears here than Bulls, but even the Bulls find this Australian complacency – even smugness – about the crisis bemusing. One insider I spoke to – admittedly a Bear – commented that he found it so annoying on his last visit to Australia that he's sworn never to return.

Good riddance might be the attitude of some; who needs the negativity? Well, we might if the causes of the crisis are not in fact peculiar to the North Atlantic.

For though the GFC might have had very little bite here so far (and I admit that the mildness of the downturn to date in Australia did surprise me) we can only kiss it goodbye if it was really just a 'northern hemisphere black swan'. If instead its causes are more general, which is why the US is now starting to fear a DDR (double-dip recession), Australia might find that it's not so lucky after all.

Here there is one indicator that I think explains why Australia has not suffered as badly as its North Atlantic counterparts, but also why there will be no easy recovery – the contribution that rising debt makes to aggregate demand. Though I am a critic of the extent to which our economies have become debt-dependent, there's one unmistakeable fact about our post-1970 recoveries – they have all involved a rising level of private debt compared to GDP.

I've recently done a comparison of how the US today compares to the US in the 1930s on this front, and the results – included in an earlier article on Business Spectator – were intriguing.

The US was actually suffering a more severe private sector deleveraging this time than in the 1930s in 1928, rising debt was adding about 8 per cent to the level of aggregate demand – that is, demand was 8 per cent higher than it would have been had debt been constant. By the depths of the Great Depression, falling debt was making aggregate demand about 25 per cent lower than it would have been had debt been constant.

The story for today is more extreme – at the end of 2007, rising debt made aggregate demand 22 per cent higher than it would have been had debt been constant – so rising debt today was almost three times as important in our pre-GFC boom as it was in the 1920s. Two and a half years later, falling private sector debt was reducing demand by almost 15 per cent. This was not as bad as the worst levels of the Great Depression, but worse than in 1931, which was the comparable time from the beginning of the downturn in private debt.

The positive difference between then and now in the US turned out to be the positive contribution to demand made by rising government debt. The government-financed proportion of demand in the Great Depression was trivial two years into the crisis, and only became substantial – at about 7.5 per cent of aggregate demand – three years in. In contrast, government spending is making aggregate demand almost 13 per cent higher now. But despite that, the US is still deleveraging.

That's the comparison between the USA of today and the US 80 years ago; what about the comparison of the US today with Australia today? The chart below provides it.

Firstly, Australia is running a couple of months behind the USA in the crisis. But that's minor compared to the difference in scale. Private debt added slightly less to demand in Australia during the boom times – a maximum of 18.75 per cent of aggregate demand was financed by private debt, compared to over 22 per cent for the US. But deleveraging hasn't even begun here – the private-debt-financed contribution to demand flirted with zero in late 2009, but has been positive throughout. Rising private sector debt today is adding about 2 per cent to aggregate demand. Rising government debt is adding about another 2 per cent on top of that.

So Australia hasn't yet delevered – in contrast to the USA. Does that mean we have a "get out of the GFC Free" card? That depends on whether we've avoided what caused the GFC in the first place – a run-up of excessive private debt during a speculative bubble.

There the answer is equivocal. While we have substantially less debt than the US (though some correspondents have argued that the RBA figures I use understate the level of finance sector debt here), our debt to GDP ratio is 90 per cent higher than it was back in the Great Depression.

So we have less deleveraging potential than the US, and we haven't even begun to do it yet – which is why the GFC has appeared to be a North Atlantic phenomenon. And if we can prevent deleveraging, then we won't see the depths of the downturn that the North Atlantic has seen either.

But there is a downside to no deleveraging. We have a household sector that is even more indebted than its US counterpart. The odds are that this sector will be debt-constrained in its spending, and the recovery will be stalled as a result. So I guess, the GFC is not entirely an NAEC.

*Three-letter acronym.

Steve Keen is associate professor of economics at the University of Western Sydney and editor of the Debt Deflation blog

(6) Deleveraging returns - Steve Keen

From: ERA <hermann@picknowl.com.au> Date: 11.06.2010 11:07 AM

Deleveraging returns

by Steve Keen

Published in Debtwatch on May 25th, 2010

http://www.debtdeflation.com/blogs/2010/05/25/deleveraging-returns/

Market economists have spent the past few months searching each major data release for confirmation of their hope that the economy is returning to growth and that a ’sustainable recovery’ is underway.

Most currently argue that the fundamentals in Australia are good – low unemployment, a strong recovery in equity markets (notwithstanding the 14 per cent sell-off in the past month) , a significant number of companies’ results beating expectations and so on.

The same economists and commentators (none of whom actually saw the GFC coming) then argue that if the recovery from the GFC is derailed, it will be because of an external shock – a China-led commodities slump, the sovereign debt crisis, or an abrupt carry trade reversal when the Fed starts raising rates (though the recent slump in the $A implies this is taking place now without the Fed’s assistance) .

What these analyses overlook is the internal indicator which enabled me (and handful of other non-orthodox economists) to anticipate the GFC in the first place: the ratio of debt to GDP, and its rate of change. On this indicator, even if none of these other ’shocks’ eventuate, Australia still faces either a recession, or a return to the unsustainable trends that set the stage for the GFC.

To understand why, we need to think back to the early 1980s when the Hawke/Keating government allowed foreign banks to flood into Australia, and when “Bondy” and “Skacy” were regarded as national heroesrather than as the Ponzi merchants that subsequent events proved them to be. This public embrace of Ponzi finance gave official backing for what was in reality a debt-driven economic system, rather than one based on real economic growth.

Rising debt became increasingly important for sustaining economic activity, and a culture of addiction to credit began that lasted (despite major disruptions such as the late-1980s interest rate blow-outs and the early 1990s recession) until 2008. Australians became increasingly comfortable with high levels of mortgage debt, because house prices were also rising; but their ‘comfort’ resulted from increases in asset prices that were themselves caused by even larger increases in debt.

That process came to an abrupt halt as 2007 came to an end, and the sudden withdrawal of debt-financed spending is what really caused the GFC, both here and overseas.

Australia then sidestepped the start of the GFC partly by fair means - a huge government stimulus, substantial interest rate cuts and a China-led export boost - and partly by foul - enticing households back into mortgage debt via the First Home Vendors Boost.

This government policy temporarily reignited the debt culture, but the continuing GFC (and a series of RBA rate rises) has finally convinced Australian households to return to the pre-FHVB tendency to delevermostly through a sharp decline in owner-occupier borrowing, as I discussed last week in “ Mortgage Finance Falters” (the data in these charts doesn’t yet reflect the substantial drop-off in owner-occupier mortgage debt; this may be because these aggregate debt figures aren’t seasonally adjusted, whereas the ABS data on new finance for housing is seasonally adjusted) .

Small business borrowing has also seen dramatic declines. In fact, only one major group of borrowers – housing investors – continues to leverage up, based on current data.

But even they seem to be reaching a plateau at about 25% of GDPand as might be expected, the increase in investor mortgage debt was triggered by the FHVB. Prior to its introduction, investor mortgage debt was trending down from 25.6% of GDP towards 24.75%. It then started to rise as the FHVB-inspired bubble took off, and hits its new peak of 26.2% in March 2010.

Widespread deleveraging is therefore the elephant in the room for economists hoping to find evidence of ’sustainable growth’ in company reports, and marginal changes to the unemployment data. If deleveraging gather pace, then unemployment will rise; if instead debt levels rise, then unemployment will fall, but based on an unsustainable trend in debt to income.

In the chart below I have used RBA data to demonstrate why this is so (the source files are D02Hist, G07Hist, and G12Hist, which themselves repackage ABS data) . The key reason is that the more Australians borrow in relation to incomes, the greater is the proportion of aggregate demand that is simply recycling of debt capital. While this causes a boom as debt levels rise, this process also works in reverse.

I calculate the proportion of aggregate demand that is debt-financed by dividing the annual increase in debt by the sum of GDP plus that change in debt. From contributing nothing to aggregate demand at the end of the early 1990s recession, debt-financed demand rose steadily to hit a peak of around 19 per cent of demand in 2008.

Now, as private deleveraging gathers pace, aggregate demand is plunging, meaning that nearly a fifth of Australia’s ‘income’ is in jeopardy because Australians are no longer willing to borrow to fund the additional spending. The First Home Vendors Boostwhich caused the turnaround in private deleveraging that is evident in the data for 2009and the increase in government debt stopped the debt contribution from turning negative (as it did in the USA) . Continuation of that trend is unlikely this yearand even if it did continue, we would be basing our continued prosperity on a return to the debt-induced growth that caused the GFC in the first place.

The final, disturbing aspect of the chart below is how closely unemployment correlates with debt-funded demand changes: since 1980, the debt contribution to aggregate demand explains 90% of the level of unemployment.

While correlation does not prove causationand there are more causal factors than just the change in debtin this instance the causal mechanism that would lead to recession and high unemployment is so simple that only a neoclassical economist could contest it. Our economy is demand-driven; as debt’s contribution to demand falls, aggregate demand slumps, and the number of jobs that can be supported by aggregate demand will also fall.

The odds are that Australia is headed for a very painful deleveraging-induced recession. We can only hope that the problem is not amplified by the “external shocks” from the still-extant GFC.

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