I don't really think it's a major problem of capitalism like Steve Keen claims, but it's important to understand.
Economists Ignore One of Capitalism's Biggest Problems - Evonomics
Economists Ignore One of Capitalism's Biggest Problems - Evonomics
CONT. at link.Joe correctly notes that “the world faces a deficiency of aggregate demand”, and attributes this to both “growing inequality and a mindless wave of fiscal austerity”, neither of which I dispute. But then he adds that part of the problem is that “our banks … are not fit to fulfill their purpose” because “they have failed in their essential function of intermediation”:
Between long-term savers (for example, sovereign wealth funds and those saving for retirement) and long-term investment in infrastructure stands our short-sighted and dysfunctional financial sector…
Former US Federal Reserve Board Chairman Ben Bernanke once said that the world is suffering from a “savings glut.” That might have been the case had the best use of the world’s savings been investing in shoddy homes in the Nevada desert. But in the real world, there is a shortage of funds; even projects with high social returns often can’t get financing.
I’m the last one to defend banks, but here Joe is quite wrong: the banks have very good reasons not to “fulfill their purpose” today, because that purpose is not what Joe thinks it is. Banks don’t “intermediate loans”, they “originate loans”, and they have every reason not to originate right now.
In effect, Joe is complaining that banks aren’t doing what economics textbooks say they should do. But those textbooks are profoundly wrong about the actual functioning of banks, and until the economics profession gets its head around this and why it matters, then the economy will be stuck in the Great Malaise that Joe is hoping to lift us out of.
The argument that banks merely intermediate between savers and investors leads the mainstream to a manifestly false conclusion: that the level of private debt today is too low, because too little private debt is being created right now. In reality, the level of private debt is way too high, and that’s why so little lending is occurring.
In fact, the period from 1945 till 1965 is now regarded as the “Golden Age of Capitalism”. There was a severe slump initially as the economy changed from a war footing to a private one, but within 3 years, that transition was over and the US economy prospered—growing by as much as 10% in real terms in some years (see Figure 1). The average from 1945 till 1965 was growth at 2.8% a year. In contrast, the average rate of economic growth since 2008 to today is precisely zero.
Figure 1: US Real GDP growth from 1945-1965 vs 2008 till now
I argue that a major reason for this unexpected Post-War turn of events was that credit expanded rapidly in the post-WWII period, and this provided a source of aggregate demand that economists back then hadn’t factored into their thinking—and as Joe shows, they’re still not doing it today. Credit grew more than 10% per year on average, fuelling an insatiable aggregate demand that drove the economy forward. In contrast, credit growth since 2008 has averaged a mere 1.4% per year—see Figure 2.
Figure 2: Rapid Post-WWII credit expansion versus anemic growth in credit today
This might seem to support Joe’s argument that banks today aren’t “fit for purpose”, whereas in the post-WWII period they were—and that’s why we are experiencing “The Great Malaise” now, rather than another “Golden Age of Capitalism”.
But there’s a factor that Joe ignores (along with the rest of the economics mainstream) because the “banks are intermediaries between savers and investors” model tells him that it doesn’t matter: the level of private debt relative to GDP. Today, private debt is more than 4 times what it was in 1945—and at its peak in 2009, it was more than 5 times the 1945 level (see Figure 3). That’s why banks aren’t lending today, and that’s why aggregate demand is growing so slowly. The only way to get out of the “Great Malaise” is to bring this level of private debt down—without reducing aggregate demand in the process (and without anything as catastrophic as WWII either).
As I noted above, that’s probably enough to convince non-economists, but it won’t persuade Joe or the economics mainstream. Their riposte would be “why does the level of private debt matter?”—after all, that’s what Ben Bernanke, another mainstream economic guru, effectively said to Irving Fisher when he dismissed Fisher’s idea that debt-deflation caused the Great Depression:
Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a re-distribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects. (Bernanke, Essays on The Great Depression, page 24)
According to the mainstream, the rate of growth of debt is generally irrelevant to macroeconomics, because lending simply redistributes spending power from savers to investors—it doesn’t create spending power in its own right. What matters is that socially useful projects are funded which then fuel economic growth. How much private debt changes every year is simply a side-effect of getting money from savers who don’t spend, to investors who do. And huge changes can occur in the level of private debt without any impact on the rate of economic growth.
For decades now, a handful of rebel economists have been disputing this—including me of course, but going back to Irving Fisher and even earlier, and including modern non-mainstream economists like Stephanie Kelton (who now advises Bernie Sanders), and University of Southampton ProfessorRichard Werner. Oh, and a guy named Hyman Minsky too, whom the mainstream ignored until the 2008 crisis. But the mainstream ignored us before the crisis, and continues to ignore us after it, because their “banks as intermediaries” model tells them that we are just spouting nonsense.
We’re not, of course: the ordinary public tends to get that, and even The Bank of England has come out and said that it’s the mainstream that is spouting nonsense, not the rebels. But the mainstream rejects our analysis out of hand,because their model tells them that it’s OK to do so.
This wouldn’t matter if we could ignore the mainstream of the economics profession, but we can’t, because they are the key individuals who influence the economic policies that are actually put in place by politicians. Keynes understood this very well in his day, noting that “the world is ruled by little else”:
“The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.” (Keynes, General Theory 1936)
If the mainstream is wrong on this point—and they are very wrong—then there’s no chance of politicians doing what is needed to overcome “The Great Malaise” (especially if the best remedy also challenges vested interests, which it surely does). So how to persuade the mainstream that, despite their Nobel Prizes, they might just be wrong?
