6 It's the Deleveraging, Stupid, by Steve Keen

(1) Australian Proposal for a "People's Bank"
(2) It's the Deleveraging, Stupid, by Steve Keen

(1) Australian Proposal for a "People's Bank"

From: James <jcumes@chello.at> Date: 09.07.2009 06:24 AM

Six Australian economists have proposed the establishment of a "People's Bank" in Australia. Some suggest it should take as its model the Commonwealth Bank of Australia created by King O'Malley about 1912 and "privatised" in the last twenty years or so.

The critical function of "control...[of]... direction of general investment" was exercised most effectively by the Commonwealth Bank for several decades after 1945; but, on being privatised, it ceased of course to exercise such control; nor was any such control exercised by the Reserve Bank of Australia (RBA).

The restoration of such control will be absolutely essential to the effective management of the Australian economy both in resolving the present crisis and in preserving growth and stability in its aftermath.

Below are some extracts from "America's Suicidal Statecraft" that set the environment for consideration of a "People's Bank" in  Australia. It is a fair conclusion that we need a comprehensive reform of our banking and financial system in Australia - just as do other countries, large and small around the world.

Speculation must be controlled, real investment must be enhanced and democratic governments must reverse what has been their shameful abdication of financial responsibility over the last thirty to forty years.

The six economists have revived memories of what Australian Prime Minister-to-be John Curtin advocated back in 1937, especially about:-

"National direction of investment with the object of assisting in the promotion of a balanced economic development. The Commonwealth bank is the logical instrument to function for the community in effecting monetary re-adjustment and economic reconstruction. The Labor Government will legislate so that the Commonwealth Bank would be able competently to control:
(a) Credit for the Nation
(b) Rates of Interest
(c) Direction of general investment
(d) Currency relations with external markets"

I hope that consideration of the re-establishment of the Commonwealth Bank of Australia as it was conceived nearly a hundred years ago - and as it was strengthened, for example, in the Banking Act and Commonwealth Bank Act of 1944 - should go ahead actively as part of a thoroughgoing re-examination of our - Australia's - financial system. That thoroughgoing re-appraisal we can undertake with some sense of voluntariness now. If we wait, it will, in any event, be forced upon us as the stresses within a desperately struggling global economy escalate.

James Cumes  

Extracts from "America's Suicidal Statecraft"

The Creation of a Casino Economy

In the 1980s, the instabilities of the previous decade prompted a simplistic, supply-side approach that called for cuts especially in personal income tax and public spending, as well as for small government and free markets. Reaganomics dovetailed well with Thatcherism which, inter alia, increasingly advocated privatisation of public enterprise and public investment. The philosophy of allowing the free market free rein went along with abdication by governments of a wide range of economic and social responsibilities. Central banks still lacking it were given independent power to manage monetary policy and especially to "fight inflation" by raising interest rates at the slightest provocation and to hold them at the higher level as long as their "responsibility for monetary stability" might, however implausibly, require. As economic policy came to mean more and more a deceptively simple matter of whether interest rates should be raised or not, economic power passed more and more out of the hands of government and into the hands of an independent authority - the central bank - not accountable in the democratic process. This abdication of power by government had international as well as domestic repercussions and was especially linked to the gutting of domestic industry - the emigration of domestic industry at an accelerating rate - that we have referred to above.

The unhappy context of inordinate market freedom linked with mechanistic and misconceived monetary regulation, helped to create innovative and structured finance and enabled it to flourish. The new finance could, inter alia, embrace the servicing of huge and accelerating domestic and overseas investment, mergers, takeovers and the like. Distributive import trades took the place of domestic production to supply consumer needs. Non-banking financial institutions multiplied. Trade in derivatives escalated. Privatisation of pensions created huge funds often seeking quick rather than secure investment returns in highly competitive environments. A casino-like domestic and international financial and trading system emerged with a robustness matched only by the wildfire spread of real, undisguised casinos all around the world. The IMF offered aid packages to post-Soviet and other countries that mandated a precipitate transition to copycat, free-market, free-wheeling, casino-like systems. Instead of being froth on the surface of the real economy, speculation became and was widely regarded, consciously or not, as more real – at least for making money – than the real economy. The advice that George Washington is said to have given to Alexander Hamilton at the founding of the Republic was ignored: speculative capital, according to Washington, was "barren and useless, producing, like that on a gaming table, no accession to itself ... [and is] withdrawn from Commerce and Agriculture where it would have produced addition to the common mass."

The Addiction to Privatisation

Apart from the philosophic and ideological appeal, privatisation was seen as bringing an end to the losses that some of the nationalised industries incurred, especially in the ‘seventies. For some industries those losses had become a chronic and ever more prominent feature. With privatisation, the burden of those losses on the budget would cease while, at the same time, the proceeds of the sale of public assets would reduce the deficit arising from other causes. If the sale were big enough, it might even thrust the budget into surplus. North Sea oil was beginning to ease the strain on national resources but the Falklands war and defence generally burdened a British economy that was still under challenge from the consequences of the political, social and economic reconstruction and reform that had marked the post-war decades.

However, what was especially appealing was the fact that privatised industries would no longer require the government to provide the investment necessary to maintain the industries – that is, even to meet the costs of depreciation – or to make available the additional funds needed to keep the industries competitive in a rapidly advancing scientific and technological environment. The government would no longer have any obligation to invest in the nationalised industries. It would not, on the one hand, have to bear the burden of making essential funds available for depreciation and new investment or, on the other, face the consequence that annual losses by the nationalised industries would grow ever larger because the government had failed to make the necessary investment to make and keep them efficient. Especially in the light of what we have said elsewhere about the crucial nature of fixed-capital investment, that was almost certainly the most vital consideration from a macroeconomic point of view. The rapid evolution of "ownership" investment in the last twenty-five years, at the expense of "production" investment, did great damage to what was traditionally viewed as solid economic growth, based on new fixed-capital investment, higher productivity and expanded production. The spur to privatisation was not necessarily the first manifestation of this evolution but it fitted nicely into the degenerative process.

It was primarily to shed responsibility for public investment that the notion of privatisation, which had begun in such an offhand and initially unconsidered way, became so formidably part of the program that characterised Conservative British Governments during the last two decades of the 20th century. It was then taken over by "New Labour" when Tony Blair came to power in 1997. For a party that had been so much in favour of – that had so powerfully advocated - nationalisation, this was an extraordinary reversal of policy but one that was, of course, not unique in democratic politics.

That this was so was confirmed by the way privatisation swept around the world. It came to be accepted and adopted, not only by conservative governments but also, for example, by the Hawke and Keating Labor Governments in Australia in the period up to 1996. Then it was taken over with equal or even greater fervour by the Liberal Government of John Howard. Almost everything in public ownership that could be profitably sold was either sold or prepared for sale to the private sector. This applied even to such profitable and iconic enterprises as Qantas Airways and the Commonwealth Bank, which consistently returned good dividends on investment, contributed usefully to public income and were among the most consistently positive contributors to growth in the country's Gross Domestic Product.

Two things are important to note. The first is that, under privatisation, it was only ownership that was transferred. The considerable sums involved in transferring ownership did not add to fixed-capital investment in the enterprises. There was no "gale of creative destruction" deriving from their sale. In that, privatisation shared the shortcomings of the takeover, merger and buyback mania that has characterised the advanced economies since 1980. The "investment" involved in those transactions changed ownership but did not necessarily entail any new fixed-capital investment or any consequent improvement in productivity or production – except through such nebulous considerations as symbiosis or the ogre of "goodwill." Indeed, some parts of the enterprise whether under privatisation or merger/takeover might be sold off and the highly leveraged costs of acquiring the enterprise might and often did seriously inhibit future new fixed-capital investment in the enterprise.

The other main feature was that, in virtually all privatisations, there was a powerful element of political expediency, going beyond the shedding of investment responsibilities. Privatisation was seen, by left- or right-wing governments, to offer certain short-term political advantages: budgets could be balanced or deficits reduced; taxes could be cut or need not be increased or increased so much; "democratic investors" from all classes could be offered "stag" gains from buying privatised shares at what was or fancied to be below market value and then selling them off quickly at a profit. In some cases, of which the Russian privatisations were probably the most notorious, massive gains were made by a few who acquired assets, for example, in the oil industry, at prices that enabled them to enrich themselves at the expense of the state. Some became so immensely rich in the privatization of Soviet assets that they became known as the oligarchs, a name implying their potentially powerful political as well as economic status. They were not the only ones who became rich, but their success put them into a special class in the post-Soviet hierarchy. Some lost their status as a result of the August 1998 financial crisis. At least one, Khodorkovsky, allegedly the richest of all, was jailed because he became too powerful and a potential threat to others, including the politically powerful or ambitious. Some retired into exile in the West. Many, if not most, survive and some count among the billionaires of present-day Russia.

The Russian and other experience of the way in which privatisation has been exploited and public assets have been looted has not diminished its appeal. Privatisation was seen to fit into a fashion of modernisation – and to symbolise the rejection of an outmoded, discredited communist/Marxist/socialist philosophy. It harmonised with notions of deregulation, free markets and free trade, small government and the conviction that trade-union power and social welfare had gone too far. Although reservations about these notions are now becoming more widespread, they have not so far noticeably halted the march of privatisation around the world.

The Role of the Reserve Bank

Like the Bank of England, the Reserve Bank in Australia, for most of its life, had no ultimate independence of government although its influence on government could be considerable and conflict between the Government and the RBA, if it were publicly revealed, might tend to reflect on the Government's standing in the electorate. Those who governed the RBA were able enough in conventional terms which meant mainly that they were devoted to their "credibility" in much the same way as those who governed the Bank of England. Neither the governors of the Bank of England nor those of the Reserve Bank of Australia, at least since 1970, have been prone to act out of any undue sympathy for the impact of their policies on their economies' growth and employment or, indeed, on the human condition in their particular diocese. Their concern has been monetary stability – although, again, there has not been much stability in the real value of the Australian dollar either at home or abroad, especially in the last thirty-five years or so. Although they have had such power to use such a formidable instrument as the interest rate, they have shown no clear understanding of the way in which the interest rate works, including, for example, its impact on asset-price inflation as distinct from consumer-price inflation and the way in which domestic inflation can shift to external trade and payments deficits.

The independence of the RBA was incomplete until the later 1990s. The bank was then empowered to make "decisions about interest rates independently of the political process – that is, it does not accept instruction from the Government of the day on interest rates. This principle of central bank independence in the operation of monetary policy, in pursuit of accepted goals, is the international norm. It prevents manipulation of interest rates for political ends, and keeps monetary policy focused on its long-term goals." However, the Government could intervene in certain circumstances to "determine policy in the event of a material difference." In a joint statement in 2003, the Government and the RBA declared that "The Government recognises the independence of the Bank and its responsibility for monetary policy matters and intends to respect the Bank's independence as provided by statute. Section 11 of the Act prescribes procedures for the resolution of policy differences between the Reserve Bank Board and the Government. The procedures, in effect, allow the Government to determine policy in the event of a material difference; but the procedures are politically demanding and their nature reinforces the Bank's independence in the conduct of monetary policy. Safeguards like this ensure that monetary policy is subject to the checks and balances inherent and necessary in a democratic system."

Independence or near-independence was originally conferred on most central banks, including those mentioned above, in a far less complex and sophisticated financial environment than the present. The 1920s decade was a period of relatively little participation or intervention by the government in the economy. Financial dealings were relatively few, relatively simple and confined usually to a relatively small number of companies and individuals. Compared with the present, financial instruments were also simple and consisted primarily of shares and government bonds. Globalisation of financial and other economic transactions was at an early and relatively primitive stage. Governments could transfer power to an independent central bank and still retain most of their sovereign economic and financial power intact. Governments could transfer power to an independent central bank without giving to that central bank such power over the economy - and over the welfare and prosperity of the society as a whole - that it, rather than the elected government, could become the dominant force for economic and financial management in a democratic community. Though interest rates were important seventy, fifty or thirty years ago, they were not so volatile, their movement did not have the same penetrative effect throughout the whole of the economy and society, and they did not provide the same opportunities for speculation as they did after 1980. They were not such chilling instruments of economic and social destruction of the ordinary individual – potentially and actually - as they have become in recent years. And perhaps above all, governments, though not participating directly or intervening in the economy to the extent that they did between 1945 and 1970, had sufficient  instruments in their hands to be able to contribute to the effective management of the economy and, if need be, balance action taken by an independent central bank.

This was not so later, in the period after 1980 and, more particularly, after 1985 or 1990. By then globalisation of financial and economic transactions had increased dramatically. Communications to facilitate twenty-four-hour-a-day transactions had undergone revolutionary change. The volume of transactions had increased massively, as well as the number of participating individuals and companies or institutions. These developments coincided with widespread deregulation by all major governments of economic and financial transactions.

They coincided also with governments' obsession with the miracles of economic stability to be derived from the independence of central banks. On 11 February 1993, French Prime Minister Beregovoy noted that the Maastricht Treaty for European Monetary Union obliged France to make its central bank independent and he saw no reason why this process should not be "accelerated". In the face of all the evidence that Governments should not abandon their responsibilities to, at best, error-prone bankers, the most responsible politicians in many countries continued to campaign - to advocate actively for themselves and others - for their country's economic and financial destiny, to be entrusted – handed over almost holus-bolus - to an independent central bank.

In brief, as governments became obsessively addicted to the concept of an independent central bank, they also consigned their country's social destiny too, to that independent central bank. It was politically correct to move in that direction. It was politically incorrect to resist. Like the obsession with a "free" market, the implications of an independent central bank were never properly thought through or at least subjected to sufficient public discussion. Politicians, academics, economists, political theorists, commentators in the media and virtually everyone else embraced the idea of an independent central bank as "good" without any deep reflection or objective analysis. Not a lot of thought was given to what Fed Chairman Greenspan alluded to in 1996: "It cannot be acceptable in a democratic society that a group of unelected individuals are vested with important responsibilities, without being open to full public scrutiny and accountability." Any accountability seemed to be confined to consideration of their limited mandate to maintain currency stability and to move interest rates up or down in a "disciplined" way, whatever the costs to the economy or the society as a whole and perhaps, especially in the case of the United States, the international community.

Although the overriding responsibility of Australia's central bank is to maintain monetary stability, we should note that the Reserve Bank Act in Australia provides that:

"It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank ... are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia."

On the face of it, these are very broad terms. However, although some rhetorical acknowledgement might be given to its full-employment,  prosperity and welfare responsibilities from time to time, the RBA's overwhelming preoccupation has, in practice, been with "the stability of the currency" and, above all, with adjusting interest rates ostensibly to promote that purpose. In this, the RBA fits into the pattern of its fellow central banks in "free-market" democracies around the world.

Independent central bankers were assumed to be "expert" and even, given the hopes that governments and others reposed in them, a unique species who might be able to work some kind of financial miracle. They were capable of doing what politicians were unwilling or unable to do because politicians were concerned with things other than the stability of the currency, including their own political future. So it was alleged. But, if the politicians' concerns were too broadly unfocussed, the concerns of central bankers were necessarily too narrowly focussed to take adequate account of social ethics, welfare, compassion or anything other than the dignity of their banknotes. They were required to deliver a stable currency - a currency with a reliable value over time internally and, in some cases, externally. (The Bundesbank, for example, was not responsible for the external value of the Deutschmark, although its influence on any final decision by the government affecting the external value would be considerable.) They were not required to flinch even at the economic consequences of their policies to "ensure" currency stability: if the economy were to fall into recession or depression, then – despite any words in their terms of reference about full employment and economic prosperity and welfare - so be it.

They were still less required to be moved by social consequences. So long  as they kept the currency stable - so long as, like Churchill's pound in the 1920s, it could look gold or the dollar or some other acceptable idol in the face - their duty was done and the "markets", infallible and god-like, would nod their approbation, perhaps even cheer. Whether anyone else would, whether the individuals exposed to the chilling objectivity of the central bankers would cheer, whether the struggling farmer near Wagga Wagga in far-away Australia, exposed by globalisation, would cheer a crippling decision announced by the Fed Chairman in Washington or the ECB Chairman in Frankfurt - a decision that might well kill his farm, his future and even himself - or whether small businessmen facing bankruptcy would cheer was another matter. The world could shatter to its component atoms, the dead by their own desperate hands could pile up outside banks' grand portals; but so long as the currency remained stable, the central bankers could rest easy. They had carried out their mandate. No more could be asked of them.

Of course, no major – or minor - currency did remain stable. Whatever "disciplines" the central bankers imposed, virtually all currencies proceeded to become progressively less stable – in real purchasing terms both domestically and internationally – especially from about 1970 onwards. If the central bankers failed in what might have been regarded as their marginal economic and social responsibilities, they failed above all in their key, crucial responsibility of "safeguarding the currency." In short, their failure was as comprehensive as the independence and responsibility we reposed in them were complete. 

The above are extracts from "America's Suicidal Statecraft: The Self-destructiion of a Superpower" (2006)

(2) It's the Deleveraging, Stupid, by Steve Keen

From: ERA <hermann@picknowl.com.au> Date: 08.07.2009 11:06 PM

It's the Deleveraging, Stupid

by Steve Keen

Published in July 4th, 2009

{visit the link to see the charts}

http://www.debtdeflation.com/.../debtwatch-36-july-2009-its-the-deleveraging-stupid/

Gentleman, you have come sixty days too late. The depression is over. – Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930

"The past may not repeat itself, but it sure does rhyme"  Mark Twain

In the last six months, the phrase "Green Shoots of Recovery" has entered the economic lexicon. It appeared to some observers that the global recession was coming to an end, while Australia itself was likely to barely feel its impact.

I would be as pleased as anyone if these "green shoots" were true harbingers of a genuine end to the economic downturn–not because I would enjoy being wrong for the sake of it, but because my expectations for the future are so bad that I'd prefer to see them not come to pass.

Unfortunately, on current data I expect that "green" is a better description of the knowledge level of those making the optimistic predictions, than of the colour of any budding economic recovery.

Of course, it could be argued to the contrary that many of those making such optimistic forecasts are highly trained professional economists, and not merely market commentators who migh have a vested interest in putting a positive spin on the news. This is true–but far from being a reason to trust these forecasts, it is yet another reason to be sceptical of them.

Almost every holder of a PhD in economics who works for a formal economic body like the Treasury, the RBA or the OECD has been deeply schooled in "neoclassical" economics, often without knowing that there is any other way of thinking about how the economy functions. They think they are simply "economists", and anyone who objects to their analysis or models must be uneducated about economic theory.

In contrast, virtually all University Departments of Economics contain at least one economist who rejects neoclassical economics, and instead subscribes to a rival school–like Austrian, Marxian, Post Keynesian, or Evolutionary Economics.

These contrarian academic economists often disagree amongst themselves, sometimes vehemently–you couldn't get two more opposed points of view than Austrian and Marxian economics, for example–but they tend to be united in regarding neoclassical economic theory as pompous drivel.

There are probably many reasons for this dichotomy between University economics departments which almost always have a handful of dissidents, and official economics bodies like the OECD and Treasury that are almost exclusively staffed by neoclassical economists. But I suspect the main reason is tenure: universities offer it, while formal economic advisory bodies don't.

As a result, academic economists who "turn feral" and reject neoclassical economics can still teach and publish and hang on to their jobs, even if their neoclassical Department Heads wish they would go away. OECD and Treasury economists who do the same thing probably find their employment coming to an end–because they don't have tenure.

So anything published by a formal economic body like the OECD will be the product of a neoclassical economic model–and therefore, in my opinion and that of a sizable minority of academic economists, drivel (there was one exception–the Bank of International Settlements [http://www.bis.org] while Bill White [http://www.bis.org/about/biowrw.htm], a supporter of Hyman Minsky's "Financial Instability Hypothesis", was its its Economic Adviser).

Of course, disputes between academic economists don't matter in the real world, and most newspapers report the announcements of bodies like the OECD as statements of wisdom about the future–until, that is, a crisis like the Global Financial Crisis makes a mockery of the OECD's neoclassical fantasies.

And what a mockery. This was the OECD's forecast for the world economy in June 2007:

ACHIEVING FURTHER REBALANCING

In its Economic Outlook last Autumn, the OECD took the view that the US slowdown was not heralding a period of worldwide economic weakness, unlike, for instance, in 2001. Rather, a " smooth"  rebalancing was to be expected, with Europe taking over the baton from the United States in driving OECD growth.

Recent developments have broadly confirmed this prognosis. Indeed, the current economic situation is in many ways better than what we have experienced in years. Against that background, we have stuck to the rebalancing scenario. Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment. (OECD Economic Outlook, Volume 2007/1, No. 81, June 2007, p. 7)

Yeah, right. Instead the global economy was already well into the greatest economic crisis of the last 60 years. The next two years tore the OECD's 2007 forecasts to shreds.

One might hope for some soul searching as a result of this–and hopefully some is occurring behind closed doors. But in a clear sign that the OECD hopes to see "Business as usual" restored in its modelling approach as well as the actual economy, its current Economic Outlook discusses the process of recovery from an economic crisis that it completely failed to foresee:

NEARING THE BOTTOM?

OECD activity now looks to be approaching its nadir, following the deepest decline in post-war history. The ensuing recovery is likely to be both weak and fragile for some time. And the negative economic and social consequences of the crisis will be long-lasting. Yet, it could have been worse. Thanks to a strong economic policy effort an even darker scenario seems to have been avoided. But this is no reason for complacency; the need for determined policy action remains across a wide field of policies…

In summary, it looks as if the worst scenario has been avoided and that OECD economies are now nearing the bottom. Even if the subsequent recovery may be slow such an outcome is a major achievement of economic policy. But this is no time to relax ensuring that the recovery stays on track and leads towards a long-term sustainable growth path will call for major policy efforts going forward. (OECD Economic Outlook, Volume 2007/1, No. 81, June 2009, pp. 5 & 7)

With its utter failure to see this crisis coming, why does anyone still take the OECD seriously? Probably for the same reason that people still generally obeyed the Captain of the Titanic after it had struck the iceberg: authority counts for a lot in a crisis, even if the person in authority actually caused it.

But it's also because it takes repeated failures before someone who asserts authority is rejected–one failure alone won't do. So rather like Napoleon in exile in Elba, the OECD is still taken seriously by economic commentators–as with Peter Martin's report ("Late in, early out of the downturn", SMH June 24th 2009):

AUSTRALIA is set to soar out of its economic downturn sooner and more sharply than forecast in the budget, according to forecasts from the Organisation for Economic Co-operation and Development understood to have the backing of the Australian Treasury.

The OECD says the local economy should shrink 0.3 per cent this year, less than any other OECD economy and far less than the contraction of 1 per cent that underlies the forecasts in the May budget.

Next year the economy should roar back 2.4 per cent, also above budget forecasts and more than any other OECD economy apart from those recovering from collapse in 2009.

The Treasurer, Wayne Swan, greeted the forecasts released overnight in Paris as evidence Australia was "outperforming every other advanced economy in the face of the recession".

The forecasts show Australia's unemployment rate reaching 7.9 per cent late next year rather than the 8.25 to 8.5 per cent range assumed in the budget.

A little scepticism in this report would have been appreciated, given the OECD's track record–and if a political journalist had written the report, that might well have occurred. But it was written by an economics correspondent, and most of them have–like the OECD's economists–been schooled only in neoclassical economics, and don't know how flimsy the theory itself is (there are exceptions here, like Brian Tookey whose book Tumbling Dice is an excellent critique of neoclassical economics). So we get a report like this trumpeting good times and green shoots, with no irony (Peter Martin was far from the only one to present the OECD's views without any scepticism–see also "Earth-destroying bomb defused – just" by Michael Pascoe [http://business.smh.com.au/business/earthdestroying-bomb-defused--just-20090625-cxj7.html] or Glenn Dyer at Crikey "That' s no green shoot, that' s Australia in full bloom: OECD" [http://www.crikey.com.au/2009/06/25/thats-no-green-shoot-thats-australia-in-full-bloom-oecd/]).

Clearly it will take a few more economic failures before the OECD faces its Waterloo.

To be fair, official economic bodies and their uncritical fans were not the only source of "green shoot" euphoria. A large part of this feeling that the worst was over also came from the global experience of a recovery in stock markets from their recent lows. In addition, Australia had a near unique dose of greenery when unemployment remained remarkably benign, and it avoided the popular definition of a recession by recording growth in real GDP in the March 2009 quarter (real GDP rose by 0.4%, having fallen by 0.5% in the preceding quarter).

Let's look first at the Stock Market

The Dow has indeed had an impressive rally, from the low of 6547 on March 9 to the peak of 8799 on June 12–a rise of 34% in under a quarter of a year. This has led to many of the usual suspects proclaiming that the bear market is over, and a new rally is underway. Comparisons with 1929 are, of course, unjustified…

On closer inspection, reports of the death of the bear market are somewhat exaggerated.

Firstly, though the index has rallied by 34% from its low, it is still down 40% from the all time peak of October 2007.

Secondly, rallies like this came and went ad nauseam in the early 1930s, until the market hit rock bottom at 41.22 points on July 8th 1932–89% below the September 3rd 1929 peak of 381.17.

The biggest such rally occurred very soon after The Crash in 1929, starting on November 13th 1929 when the market was down 48% from its September peak. It then rose almost 50% from its low in under 6 months–and it was this recovery that inspired Hoover's Oval Office gaffe.

But the market had only recovered half of what it had lost when the rally ran out of steam–a 50% fall followed by a 50% recovery still leaves you 25% below where you started from–and the inexorable slide of the Great Depression dragged the market down with it.

This current rally took a lot longer to start than its 1929 cousin, though it began from a comparable bottom (55% below the peak versus 48% below it in 1929), and it still has to go on for much longer and drive the market much higher to match its antecedent–let alone to proclaim the 2007 Bear Market is over (note also that Eichengreen and O' Rourke, using global data, argue that the current decline is far worse than in the Great Depression, with global markets down 50% on average 12 months after the crisis versus just 10% down after 1929–see Figure 2 in http://www.voxeu.org/index.php?q=node/3421).

Meanwhile, in the Real World…

Though the stock market was providing some good cheer in the USA (at least until last week), the real economy continued to disappoint. To get an idea of just how bad the downturn has been, and how little inkling of it that conventional economists had, consider the Economic Report of the President, prepared by the US President's Council of Economic Advisers ( http://www.whitehouse.gov/administration/eop/cea/]), in 2008 ( http://www.gpoaccess.gov/eop/2008/2008_erp.pdf) and 2009 ( http://www.gpoaccess.gov/eop/2009/2009_erp.pdf).

The 2008 Report made the following forecasts–note in particular the "forecast" that unemployment would be below 5 percent between 2008 and 2013.

The 2009 Report, submitted to Congress and the incoming President in January of this year, made a mockery of the 2008 Report but still drastically underestimated the severity of the downturn: it forecast that unemployment would peak at 7.7% in 2009, growth would remain positive for the next five years.

Despite the frequency with which numerous economists who failed to anticipate the Global Financial Crisis continue to report sightings of "green shoots of recovery", the actual economic data continued to be grimmer than even their most pessimistic revised forecasts.

The clearest evidence here is that the Federal Reserve's "stress tests" for its Supervisory Capital Assessment Program assumed that even under an adverse scenario, unemployment would be below 9 percent by mid-2009. It is currently 9.4 percent (see https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijcHeK5wIr86G7dQV2lsqzc_hct4Vfc08JPekHwJPwxMOJLClR19c6FHE48vbVQo6waRI47MpM8G8xv961AzaV3iZuDPfV6oixVyYRr6iYVwVmrymp9C88o7Ylm2MPpBV_VVaU8RFO1Ce4/s400/unemployment+projections.png):

The tapering process that is built into neoclassical economic forecasts (see http://www.phil.frb.org/research-and-data/real-time-center/survey-of-professional-forecasters/2009/survq209.cfm) is not evident in the data to date.

Deleveraging and Economic Breakdown

The reason that most economists continue to underestimate this downturn is because (a) the downturn is being driven by deleveraging from literally unprecedented levels of private debt, and (b) the neoclassical theory of economics, which dominates academic and market economics alike, ignores the role of private debt in the economy.

The reason that I anticipated this crisis four years ago is that I reject the mainstream "neoclassical" approach to economics, and instead analyse the economy from the perspective of Hyman Minsky's "Financial Instability Hypothesis", in which private debt plays a crucial role. In our credit-driven economy, demand is the sum of GDP plus the change in debt. If debt is low relative to GDP, then its contribution to demand is relatively unimportant; but if debt becomes large relative to demand, then changes in debt can become THE determinant of aggregate demand, and hence of unemployment.

That is manifestly the case in America today. Under the stewardship of neoclassical economics in the personas of Alan Greenspan and Ben Bernanke, the growth in private debt has not merely been ignored but has actively been encouraged, in the dangerously naive belief that the private sector is being "rational" when it borrows.

This apparent indictment of the private sector as therefore "irrational" is in fact really an indictment of neoclassical economics for abuse of language. What neoclassical theory means by the word "rational" is "able to correctly anticipate the future"–which is the definition, not of rationality, but of prophecy.

There is nothing "irrational" about being unable to predict the future–it is fundamentally uncertain, while modern economic theory hides from this reality just as Keynes's contemporary economic rivals did in the 1930s when he wrote that:

I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future. (Keynes, "The General Theory of Employment", Quarterly Journal of Economics 1937)

Instead, in the uncertain world in which we live, the private sector necessarily speculates about the future–and some of those speculations will be wrong. The role of regulation and government economic policy should be to confine those speculations, as much as is possible, to productive pursuits rather than gambles about the future path of asset prices–a pasttime that has always in the past led to Ponzi asset bubbles.

This time, with government policy driven by neoclassical economics and its deluded attitudes towards the future, policy has actually encouraged  the private sector to borrow to indulge in two giant Ponzi Schemes–the stock market and (belatedly) the housing market. It has gambled with borrowed money that share and house prices would always rise faster than consumer prices.

That gamble worked for some decades, but it then failed–in 1987-89. Had the Greenspan Fed not intervened then to "rescue" Wall Street, there is every possibility that the US would have experienced a mild Depression then–mild because the level of debt was lower then that at the time of the Great Depression (165% in 1989 versus 175% in 1929), and crucially because the rate of inflation then was high (5% in 1989 versus 0.5% in 1929).

The lower level of debt would have meant that less deleveraging would have been required to return to a predominantly income-financed economy in 1989 than was required in the 1930s, while high inflation would have meant a lower likelihood of deflation during the Depression itself, and possibly that inflation alone could have eroded the debt burden. It still would not have been pretty–certainly it would have been worse than the 1983 recession, when unemployment as it is currently defined peaked at 10.8 percent.

But what we face now will be far worse, because deleveraging from the now unprecedented debt level of almost 300% of GDP will drive America into a Depression that could easily be deeper than that of the 1930s.

This is already becoming apparent in the data, as economic historians Barry Eichengreen and Kevin O' Rourke have pointed out (see "A Tale of Two Depressions" at http://www.voxeu.org/index.php?q=node/3421):

To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimise this alarming fact. The " Great Recession"  label may turn out to be too optimistic. This is a Depression-sized event.

The comparison of unemployment rates (which Eichengreen and O' Rourke didn't make) bear this out: using the current OECD definition of unemployment, this downturn is well ahead of the 1979 recession even though unemployment started from a lower level; and using the much broader U-6 definition (see www.bls.gov; http://www.bls.gov/news.release/empsit.t12.htm), which is more strictly comparable to the NBER definition used during the Great Depression, unemployment now is as bad as at the same stage of the Great Depression, and increasing as rapidly.

Deleveraging is already extreme: the most recent flow of funds data shows that private debt is falling rapidly and therefore subtracting from aggregate demand rather than adding to it. As noted in earlier Debtwatch Reports, in the modern debt-dependent economy, changes in the demand financed by changes in private debt are strongly negatively correlated with the unemployment: when debt's contribution to demand falls, unemployment rises.

The turnaround in debt growth in the USA is unprecedented in the post-WWII period. Even during the 1980s and 1990s recessions, debt continued to grow both in nominal terms and as a percentage of GDP. Now debt is falling at arate of almost US$2 Trillion a year (which equates to 14 percent of GDP).

This is why the crisis exists, is so much worse than the official economic forecasters expected, and will continue and be much deeper than they currently believe: the crisis is being driven by deleveraging, and neoclassical economists do not even include private debt in their models.

As noted in earlier Debtwatch Reports, there is a very strong link between the rate of growth of debt and unemployment: when debt grows more quickly, unemployment falls; when debt grows slowly or falls, unemployment rises.

This is not because debt is a good thing, but because our economies have become so debt-dependent that changes in debt now have a far stronger influence on economic activity than do changes in GDP.

The US Government is attempting to "pump-prime" its way out of trouble by public-debt-financed deficit spending, which raises three further issues:

this so-called Keynesian remedy can work when private debt levels are relatively low, and government policy to attenuate private speculation is strictly adhered to (see my 1995 paper Finance and Economic Breakdown);

however, in our rampantly speculative economies, this policy has only worked when it has re-started the private debt binge, resulting in rising debt levels over time;

this can't happen this time around, because all sectors of the private economy–businesses both real and financial, and households–are already debt-saturated. There is no "greenfields" group to lend to, as was possible in 1990 when household debt was a "mere" 60% of GDP, and the derivatives market in finance had yet to explode; and finally

the scale of the private debt bubble os just too big to be countered by substituting public debt for private debt.

This last point is evident in the data. Even though the US government has thrown the proverbial kitchen sink at government spending, the increase in public debt (which adds to aggregate demand) is more than counteracted by private sector deleveraging (which subtracts from aggregate demand):

Total US Debt is therefore falling. Though in the long run this is a good thing–we must return to a non-debt-dependent economy and once we have gotten there, stay there–the transition will be as pleasant as Cold Turkey is for a heroin addict.




On closer inspection, reports of the death of the bear market are somewhat exaggerated.



Firstly, though the index has rallied by 34% from its low, it is still down 40% from the all time peak of October 2007.



Secondly, rallies like this came and went ad nauseam in the early 1930s, until the market hit rock bottom at 41.22 points on July 8th 1932–89% below the September 3rd 1929 peak of 381.17.

The biggest such rally occurred very soon after The Crash in 1929, starting on November 13th 1929 when the market was down 48% from its September peak. It then rose almost 50% from its low in under 6 months–and it was this recovery that inspired Hoover's Oval Office gaffe.



But the market had only recovered half of what it had lost when the rally ran out of steam–a 50% fall followed by a 50% recovery still leaves you 25% below where you started from–and the inexorable slide of the Great Depression dragged the market down with it.

This current rally took a lot longer to start than its 1929 cousin, though it began from a comparable bottom (55% below the peak versus 48% below it in 1929), and it still has to go on for much longer and drive the market much higher to match its antecedent–let alone to proclaim the 2007 Bear Market is over (note also that Eichengreen and O'Rourke, using global data, argue that the current decline is far worse than in the Great Depression, with global markets down 50% on average 12 months after the crisis versus just 10% down after 1929–see Figure 2 here).

Meanwhile, in the Real World…

Though the stock market was providing some good cheer in the USA (at least until last week), the real economy continued to disappoint. To get an idea of just how bad the downturn has been, and how little inkling of it that conventional economists had, consider the Economic Report of the President, prepared by the US President's Council of Economic Advisers, in 2008 and 2009.

The 2008 Report made the following forecasts–note in particular the "forecast" that unemployment would be below 5 percent between 2008 and 2013.



The 2009 Report, submitted to Congress and the incoming President in January of this year, made a mockery of the 2008 Report but still drastically underestimated the severity of the downturn: it forecast that unemployment would peak at 7.7% in 2009, growth would remain positive for the next five years.



Despite the frequency with which numerous economists who failed to anticipate the Global Financial Crisis continue to report sightings of "green shoots of recovery", the actual economic data continued to be grimmer than even their most pessimistic revised forecasts.

The clearest evidence here is that the Federal Reserve's "stress tests" for its Supervisory Capital Assessment Program assumed that even under an adverse scenario, unemployment would be below 9 percent by mid-2009. It is currently 9.4 percent. The tapering process that is built into neoclassical economic forecasts  is not evident in the data to date.

Deleveraging and Economic Breakdown

The reason that most economists continue to underestimate this downturn is because (a) the downturn is being driven by deleveraging from literally unprecedented levels of private debt, and (b) the neoclassical theory of economics, which dominates academic and market economics alike, ignores the role of private debt in the economy.

The reason that I anticipated this crisis four years ago is that I reject the mainstream "neoclassical" approach to economics, and instead analyse the economy from the perspective of Hyman Minsky's "Financial Instability Hypothesis", in which private debt plays a crucial role. In our credit-driven economy, demand is the sum of GDP plus the change in debt. If debt is low relative to GDP, then its contribution to demand is relatively unimportant; but if debt becomes large relative to demand, then changes in debt can become THE determinant of aggregate demand, and hence of unemployment.

That is manifestly the case in America today. Under the stewardship of neoclassical economics in the personas of Alan Greenspan and Ben Bernanke, the growth in private debt has not merely been ignored but has actively been encouraged, in the dangerously naive belief that the private sector is being "rational" when it borrows.

This apparent indictment of the private sector as therefore "irrational" is in fact really an indictment of neoclassical economics for abuse of language. What neoclassical theory means by the word "rational" is "able to correctly anticipate the future"–which is the definition, not of rationality, but of prophecy.

There is nothing "irrational" about being unable to predict the future–it is fundamentally uncertain, while modern economic theory hides from this reality just as Keynes's contemporary economic rivals did in the 1930s when he wrote that:

"I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future." (Keynes, "The General Theory of Employment", Quarterly Journal of Economics 1937)

Instead, in the uncertain world in which we live, the private sector necessarily speculates about the future–and some of those speculations will be wrong. The role of regulation and government economic policy should be to confine those speculations, as much as is possible, to productive pursuits rather than gambles about the future path of asset prices–a pasttime that has always in the past led to Ponzi asset bubbles.

This time, with government policy driven by neoclassical economics and its deluded attitudes towards the future, policy has actually encouraged  the private sector to borrow to indulge in two giant Ponzi Schemes–the stock market and (belatedly) the housing market. It has gambled with borrowed money that share and house prices would always rise faster than consumer prices.

That gamble worked for some decades, but it then failed–in 1987-89. Had the Greenspan Fed not intervened then to "rescue" Wall Street, there is every possibility that the US would have experienced a mild Depression then–mild because the level of debt was lower then that at the time of the Great Depression (165% in 1989 versus 175% in 1929), and crucially because the rate of inflation then was high (5% in 1989 versus 0.5% in 1929).



The lower level of debt would have meant that less deleveraging would have been required to return to a predominantly income-financed economy in 1989 than was required in the 1930s, while high inflation would have meant a lower likelihood of deflation during the Depression itself, and possibly that inflation alone could have eroded the debt burden. It still would not have been pretty–certainly it would have been worse than the 1983 recession, when unemployment as it is currently defined peaked at 10.8 percent.



But what we face now will be far worse, because deleveraging from the now unprecedented debt level of almost 300% of GDP will drive America into a Depression that could easily be deeper than that of the 1930s.

This is already becoming apparent in the data, as economic historians Barry Eichengreen and Kevin O' Rourke point out in "A Tale of Two Depressions":

"To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimise this alarming fact. The " Great Recession"  label may turn out to be too optimistic. This is a Depression-sized event."

The comparison of unemployment rates (which Eichengreen and O' Rourke didn't make) bear this out: using the current OECD definition of unemployment, this downturn is well ahead of the 1979 recession even though unemployment started from a lower level; and using the much broader U-6 definition, which is more strictly comparable to the NBER definition used during the Great Depression, unemployment now is as bad as at the same stage of the Great Depression, and increasing as rapidly.



Deleveraging is already extreme: the most recent flow of funds data shows that private debt is falling rapidly and therefore subtracting from aggregate demand rather than adding to it. As noted in earlier Debtwatch Reports, in the modern debt-dependent economy, changes in the demand financed by changes in private debt are strongly negatively correlated with the unemployment: when debt's contribution to demand falls, unemployment rises.

The turnaround in debt growth in the USA is unprecedented in the post-WWII period. Even during the 1980s and 1990s recessions, debt continued to grow both in nominal terms and as a percentage of GDP. Now debt is falling at arate of almost US$2 Trillion a year (which equates to 14 percent of GDP).



This is why the crisis exists, is so much worse than the official economic forecasters expected, and will continue and be much deeper than they currently believe: the crisis is being driven by deleveraging, and neoclassical economists do not even include private debt in their models.

As noted in earlier Debtwatch Reports, there is a very strong link between the rate of growth of debt and unemployment: when debt grows more quickly, unemployment falls; when debt grows slowly or falls, unemployment rises.



This is not because debt is a good thing, but because our economies have become so debt-dependent that changes in debt now have a far stronger influence on economic activity than do changes in GDP.

The US Government is attempting to "pump-prime" its way out of trouble by public-debt-financed deficit spending, which raises 4 further issues:

1.this so-called Keynesian remedy can work when private debt levels are relatively low, and government policy to attenuate private speculation is strictly adhered to (see my 1995 paper Finance and Economic Breakdown);

2.however, in our rampantly speculative economies, this policy has only worked when it has re-started the private debt binge, resulting in rising debt levels over time;

3.this can't happen this time around, because all sectors of the private economy–businesses both real and financial, and households–are already debt-saturated. There is no "greenfields" group to lend to, as was possible in 1990 when household debt was a "mere" 60% of GDP, and the derivatives market in finance had yet to explode; and finally

4.the scale of the private debt bubble is just too big to be countered by substituting public debt for private debt.
This last point is evident in the data. Even though the US government has thrown the proverbial kitchen sink at government spending, the increase in public debt (which adds to aggregate demand) is more than counteracted by private sector deleveraging (which subtracts from aggregate demand):