Recession is Only the Beginning | BTalk Australia

(18min 54) Professor Steve Keen says the Aussie economy has a long way to fall yet. The current situation is the work of neoclassical economists who didn’t understand the importance of controlling debt, which is now over $2 trillion. He points to the RBA, whose decision not to lower interest rates last week is a further indication that most experts fail to realise the significance of the downturn. Keen still believes we are heading for a Depression.

What do you think? What will stop the slide? Add your views in the Talkback section at the end of this post.

See also:
Will Debt Drive Us to Depression? | BTalk Australia
A Waste of Taxpayers’ Money | BTalk Australia
Government and the Economy | BTalk Australia
The Business Council on the Rudd Stimulus Package | BTalk Australia
Where Do We Draw the Line on Capitalism? | BTalk Australia

Read more in Steve Keen’s Debtwatch blog.

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• Transcription

Phil Dobbie: Hello, I’m Phil Dobbie and welcome to BTalk Australia. Today, are you one of those optimists who believes the Australian economy can scrap through without going into recession. Well today, maybe our guest can help change your mind.

Dobbie: Last October we spoke to the economist professor Steve Keen from the University of Western Sydney, he said that high household debt was driving the economy towards another great depression. The difference was this time, we had twice the level of debt that we had back in the 30’s. So back then, he forecast things would get a lot worse, much worse, but presumably Steve, you still think we’ve got a lot further to go?

Steve Keen: Unfortunately, we have, it’s only slowly dawning on people, this is as serious as I was saying it was and this is only the very beginning, so to get a 0.5 percent drop in Australian GDP in the last quarter is just the very beginning of a major downturn. Of course, we are saying we’re seeing dramatic turns in America and what could well be the complete collapse of Eastern Europe.

Dobbie: Now, we’re so close to that definition of a depression aren’t we, really? If two quarters back, if the GDP had been 0.2 percent less than we would have fitted the technical definition of what a recession is, but last time we spoke, you said the D word. Now what is the definition of a depression? And do you still think we are going to get there?

Keen: It will be a depression and in some ways, a depression is a bigger and worse recession, but if you want to look for defining characteristics of depression in past historical data then it also involves falling prices amplifying the debt problem that caused the depression in the first place.

And we’re already seeing that in the American data in particular, so you had one quarter, I think it was the month of November last year, the rate of fall of consumer prices was about 2 percent and that was the second largest monthly fall on record. The only time we had a fall as high as that was back in 1933.

Dobbie: Now, we are not seeing that here though are we yet?

Keen: We’re not seeing it yet and there are complicating factors for the Australian economy because we are even less of an industrial power these days than America has turned itself into. So a lot of our goods are coming in imported and the confusion that it causes in currency terms swamps what might be actually happening in the underlying costs.

I think we will see it and one of the other things that is going to occur as well is all the CPI weightings, all the producer price index waiting and so on, are based on a particular pattern of consumption and that pattern of consumption is going to go out the window, so we might still see recorded levels of the inflation courtesy of the CPI because of the weightings they put on, say for example, plasma television screens, nobody will be buying them anymore and we look back and do a revision of seeing what is the actual cost to people of what they are actually buying, we’ll find that falling, but of course also, in the context of collapsing incomes.

Dobbie: Now you mentioned plasma screen TV’s, everyone criticised Kevin right just before Christmas for buying one for lots of people. Do you think that actually did skew the statistics and did it just forestall the inevitable?

Keen: Yes, it certainly skewed the statistic. You take out the amount of money, but if even only one third of that $10 billion injection was actually spent, then you got a $3 billion boost turning up in one quarter and that’s a fairly substantial boost on usual levels of consumption. So if we take it out of the figures, the figures would be a damn sight worse and trouble is you simply can’t continue doing that in the way the level of deleveraging the private sectors are likely to be engaging in now.

Dobbie: We hear a lot of people, a lot of politicians and a lot of economist, saying that it’s going to be bad but it’s not going to be as bad as the rest of the world here in Australia. Why are they saying that and are they right to say that?

Keen: I think it’s because they have got kangaroos on their brain, pardon me, but I am getting really sick of this one, it’s just like the China stuff I used to have to put up with when people say we are going to be saved because of the export to China and now we’re saying that China may actually fall faster than America in some ways because the Chinese economy’s performance was based very heavily on investment. With that investment being predicated on successful sales of the export and export sales of commodities. So the collapse of the American consumer market, that has drastically reduced the profitability of those investments in China and that’s feeding right back through to us in terms of coal and iron ore and other sales we make to China, so China rather than trying to be a way of keeping us warm, is actually making a way for us to freeze slightly faster. So there’s a whole range of factors like that for the fight of the Australian economy.

The demand for our products is largely a derived demand. We don’t produce, nobody eats iron ore, OK, nobody wears wool, they have to have it processed and on-sold and if the on-sale demand for consumers collapses, which is what we are seeing, then the demand for our products will fall. Again, our prices of our exports and the demand income elastic than the products we are actually having sold by the people who buy the raw materials off us. So we’ll see a complete plunge now in terms of trade. We put the terms of trade plunge together, the plunge and export as well, we’re going to get an amplified hit here from the global downturn. And, of course, on top of that we’ve got our own domestic problem where we’ve actually got a higher level of household debt compared to income than America has.

Dobbie: Yes, which you mentioned last time. So it sounds like it’s inevitable. It’s going to hurt. And I guess the question is how do we minimise that hurt in the mean time, as reserve banks levelled off interest rates last week. Many people were expecting that they were going to keep on going down. Was that a bad move on the part of the RBA?

Keen: Like everything else they’ve done. I mean, pardon me, I’m getting, my level of politeness is going to decline.

Dobbie: It’s going to be more fun every time we talk to you, I can tell.

Keen: I’m afraid so. When I started making these noises, the reason I came out was because I saw this coming three years ago. In 2005 is when I saw the data. I started doing the research on the potential for debt deflation back in 1987. I published my first academic papers in ‘95, and I was seeing the possibility of this, but I had no idea just how bad the numbers were getting. And of course, during the whole time, you had what are known as neo-classical economists touting how wonderful the economy was. Ben Benacke, actually, in 2004 was still contributing to a debate called the great moderation, and talked about the welcome change in our economy, a drop in veracity etcetera, etcetera. So these guys who are in charge now are setting up the problem by not even being aware of how a market economy functions.

Dobbie: How wrong is he?

Keen: Extremely. Totally wrong. And now, of course, we’re relying upon him and his cousins in central banks around the world to fix up a problem that they didn’t see coming and they don’t understand. So my politeness level will drop and on those particular cases, I put a blog out today of the RBA decision saying the RBA doesn’t get it.

Dobbie: But wasn’t one of your criticisms of the RBA was that they kept the interest rates so low for so long, which is why we got into this high level?

Keen: No, it wasn’t that criticism, they cut themselves back to having only one instrument and they trusted the market to respond to their price signals and set the correct level of debt and their typical, conventional economic thinking about how markets operate, which is not particularly correct for real markets and totally wrong for financial markets. So they banned all the quantitative controls they used to have, they let the regulation rip, they did everything they possibly could to encourage an orgy of lending. And interest rates were always futile as a way of controlling that.

Dobbie: So pretty meaningless, do you think?

Keen: Meaningless but dangerous, because you take a look through some of the statements of various members of the reserve bank, about how the market is more efficient now, how equilibrium we’ve reached in house to household debts to income ratios, etcetera, etcetera. Delusional.

And I think that’s slowly becoming obvious to the political leaders in Canberra because politicians are not economists, but, as they have to do in many ways, they find themselves trusting in every area, people who call themselves experts. Now if they’re trusting people about climate change, in my opinion, they’re trusting experts, if they’re trusting people about engineering work, they’re trusting experts, they’re trusting economists, they’re trusting people who’ve got no idea of how the economy functions, and that will slowly dawn on them.

Dobbie: The government’s in a difficult situation isn’t it? On the one side, as you say, we’ve got this high level of household debt here in Australia. And on the other side, the government’s saying hey, we need to encourage people to spend because we need to boost the economy and try and forestall the down turn in the economy. They can’t do both, can they?

Keen: No, they can’t. And the thing is, the way that we’ve gotten out of every previous financial crisis we’ve been in since the early 70’s is by the government pumping money into the system in such a way that it re-liquefies people who got themselves in conditions of serious bankruptcy during the recession and then re-encourages private lending. So you look back to the 1990’s, the debt level, the Australian debt GDP ratio in the 1990’s bubble, peaked at about 90 percent of GDP and then fell back to 85 percent in the recession we had to have. Now, what then happened is once they got down to that level, the boost the government gave to the system re-encouraged that level of speculative buying to take off again and we got up to 170-, including corporate, 177 percent of GDP as debt. At this stage, we have a household sector with five times the level of debt it had during the 1990’s recession. We have a business sector that actually has one and a half times as much debt as it had during the 1990’s recession. Who are you going to lend to?

There isn’t anybody else left anymore. So the old gearing way of getting out of this dilemma is no longer there, and therefore this is going to be a long term running one. All the government really can do, they certainly can’t reboost the economy. What I’d rather see them doing now is getting ready to take the pain away from those who are going to lose their jobs. So I’d like to see drastic changes in terms of the dole so that you no longer have that waiting period that applies when you lose your job. Changes to the asset test so you don’t have to spend your money before you actually get the payments. All those sorts of things are punitive and, of course, they take cash out of the economy at a time when it does need the certain injection from the government. So those sorts of things ameliorate the damage, but in terms of believing that can turn the ship around, it’s too late.

Dobbie: I was going to ask about how we actually get rid of the debt, if debt is the problem. If there is a bank doing lower interest rates, then getting people to pay off as much of that capital as quickly as possible is one element. But how do you really get rid of this debt in a way that’s going to be fair and equitable?

Keen: I think forget fair and equitable. My argument is you’ve got to ultimately start writing the debt off. And it’s only question of whether you do it piece by piece, person by person or you do it in a more collective fashion. If you do it piece by piece and person by person, we’ll be in the same situation Japan’s been in for the last two decades and it’s hardly cheerful. We can now see that Japan only managed to avoid absolutely tumultuous collapse by the fact that it could sell exports to the rest of the world, which is borrowing money to buy the goods off Japan. Now that that’s come to an end, the Japanese economy is tanking even faster than it did back in 1990. And unfortunately, we don’t have the possibility of selling another Japan, unless we actually find living beings on Mars who want to buy SUV’s. So that route is gone. And we have to write the debt off. And if we write it off collectively, that’s simply reducing debt by government interference, then that would be less painful than the long, drawn out approach. But it will mean necessarily bankrupting the financial system and starting all over again. Now that won’t happen in Australia for some time, because we still, in my opinion, falsely believe that our financial system is safe. In America, it may happen very soon.

Dobbie: But it’s not teaching great behaviour, is it? It’s almost showing: if you misbehave the government’s going to be there to save you.

Keen: Isn’t that what we’ve been doing for the last 40 years? I’m talking about wiping people out here, I know that the gun holders, the shareholders in companies, which have been involved in this, would lose their assets.

Dobbie: That would hurt.

Keen: That would hurt. And it would have to hurt bad, really bad, because that’s why we had such a responsible financial system in the 50’s. And we got rid of that — Marvin Minksy who was the only person who really understood this on a global scale before it all happened. Minsky argued that when you have a period of instability, it encourages a destabilising behaviour. Both by the financial system, but also unfortunately, by the regulators. So we’ve been doing this, the green span put as what’s led us to having twice the level of debt we had before the great depression. And that was the classic encouragement of irresponsibility. I’m afraid it’s a bit like somebody who’s been living in a brothel and doing it off money they’ve gained by the mafia saying it would be really, really nasty if you came inside and shut the system down. It’s just breathtaking that they’re finally discovering morality after 60 years of immoral finance.

Dobbie: What are your predictions for this year? You obviously think there’s a wave of unemployment that we haven’t seen yet that’s going to be the next great wave to hit us.

Keen: Yes, in the ages survey I stuck my neck out and said that I expect about 9 percent by the end of the year. It might not get that high because these things have inertia to them. But I certainly expect by the middle of 2010 to be in substantial double digit on the unemployment levels.

Dobbie: And deflation?

Keen: Deflation probably for the Australian economy, it may not turn up, as obviously in the data because our CPI’s will be utterly unreliable courtesy of the waiting ball going out the window as people drastically cut back on consumption. So the things people spend money on will drop in price quite radically, things they can no longer afford to buy might well rise because they’re imported. So that will be a bit of confusion. But certainly yes, effective deflation.

Dobbie: The last time we spoke, you were predicting house prices were going to fall by 40 percent. I mean they’ve gone a fair way towards that but we’re not to that extent. Do you think we are going to continue seeing that? I guess that becomes a natural follow on from the unemployment. Doesn’t it?

Keen: Well when I said that 40 percent, it was over the context of the over 10- to 15-year period, which is the same length of time it took in Japan. And I still think that’s highly likely to happen over that time period. In a shorter time period, you could see how quite substantial falls in the upper end of the market now. 40 and 50 percent in the year is quite feasible in some upper market sales because people have been screwed by margin goals, as you and I both know. But the broader market may take longer. The reality there is that when you have a level of debt in Australia spread across the whole communities as wide as it is, if anybody who’s got a mortgage loses their job, then they can’t support the mortgage any more.

There’ll be a drastic increase in mortgage sales, that will hit house prices and then that will cause a credit crunch.

And we’ll then see just how financially viable our banks really are.

Dobbie: I live in Wahroonga, you know, I think half the population worked in the finance sector, there are so many houses up for sale already in this part of town. So, you’re saying high unemployment deflation. What do we see next?

Keen: Serious political change as well because a large part of why people were politically quiescent and accepting the growth of what I call kleptocratic managerialism, over the last 20 years, is because we’re persuaded these guys know what they’re doing, they’re the experts etcetera, etcetera. It’s not going to be a very pleasant outlook when people start losing their jobs courtesy of that. And they’ve all got cars. And I’d watch out for some of those houses in Wahroonga. So I see very serious political change, very ugly stuff. And then slowly, the realisation by the government that they’ve got to break a whole lot of the rules of what they thought were responsible conservative economic behaviour to get out of this.

Dobbie: That’s going to take a while though. Isn’t it?

Keen: Yes, it’ll take a while. We tend to think that political systems are stable because they don’t change on the scale of their own lifetimes. But, remember the Liberal party didn’t exist prior to the Second World War and the great depression. That was a party that was formed out of the ruins of the previous political conservative party and the ruins occurred during the great depression. So that danger is if the whole political formations we’re used to will also shift.

Dobbie: Are we going to see a Steve Keen party perhaps?

Keen: I think we might. One of the reasons I dived into those was because I was desperate to avoid the possibly of right winged demagoguery could take over people’s interpretation right from the outset. And if you didn’t have somebody putting forward an effectively progressive analysis overall and saying this is going to happen, this is why, and these are potential solutions to it though solutions will be like cutting off gangrenous legs. You survive but you can’t walk anymore. I’m certainly not talking a painless solution to this problem. But unless you have somebody making those comments and all the right wing demagogues and people that raise the explanation to think we’d come to the fall. I still think that’s highly likely. But, at least there’s some possibility that people who’ve got at least a xenophobic view of how the world operates might also rise in political influence.

Dobbie: Steve, listen, I thought I was going to have a good day until I spoke to you. Once again, you’ve ruined it for me. Tell me, are you finding that you’re getting invited to less parties these days?

Keen: I’m getting invited to more parties. This is one of the ironies of the whole thing. A previous partner asked me what’s going to happen to us in this whole thing. I said we’re going to be on easy street. The only person who called it before it happened in Australia, along with having great friends like Muriel Neven these days. I’m going to be getting plenty of good invitations because it’s the classic story when you’ve got somebody who can see their way through the fog, you might not like what they tell you is on the other side of the fog, but you’d rather that than the bugger who can’t even see there’s a fog kind of obscuring his vision.

Dobbie: And the good thing is if you’re getting invited to parties and the times are going to be as hard as you say just make sure you take some food back with you.

Keen: I will do that.

Dobbie: Thanks for your time Steve.

Keen: You’re welcome.