Alan Greenspan, who headed the Federal Reserve Bank for 18 years, now acknowledges flaws in the economic model he used. But the fact is, very few economists predicted the "Great Recession" which started in December of 2007. That is almost tantamount to weathermen missing the storm of the century. And it is worse than that, claims Australian economist and author of "Debunking Economics," Steve Keen. Not only did most economists fail to forecast the economic crisis; they operate with theories that say it can not happen. Weather experts might occasionally miss big storms, but they have not propounded theories which claim that major storms are impossible.
Keen, who is thoroughly conversant with all the economic literature, argues that mainstream economists often miss the big picture. In recent decades, there has been a strong emphasis on microeconomics (the part of economics which theorizes about the behavior of individuals and individual firms etc.) in which economic forces are always working toward a greater balance and improvement ("equilibrium" in the parlance of economists). He maintains that a profound knowledge of microeconomics provides no understanding of the economy as a whole. While he challenges many concepts of mainstream economics, he is particularly critical of its neglect and ignorance of private debt and banking in the economy.
Keen draws on the remarkable and discerning insights of many economists normally relegated to the periphery: Karl Marx, Hyman Minsky and Piero Sraffa. Although Keen criticizes some aspects of Marx, Keen uses many of Marx's penetrating insights to show how many mainstream economists, especially those focused on microeconomics, have essentially based their theories on barter economies.
In a barter economy, exchanges are made to obtain items with different qualities. For example, a coat producer gives up a coat (with has little or no nutritional value) to obtain food (which has nutritional value). Since all exchanges are mutually beneficial and win/win, the only problems come from outside the economy -- such as a drought or earthquake, etc. Even if money, operating as a medium of exchange, facilitates the barter (so that the car dealer does not have to accept 10,000 loaves of bread) the exchanges can be summarized: commodity to money to commodity.
In contrast to the above type of exchange, a capitalist makes exchanges primarily to obtain a greater quantity of money. For example, a capitalist might inject $10 million into the economy so that he might extract $12 million. To illustrate the snag or impasse that might occur, imagine all the capitalists in the world injecting $100 billion to pay for the resources used to produce goods and services and then aiming to sell those goods and services to people, who were paid a total of $100 billion, for $120 billion. Where will the extra $20 billion come from?
Marx saw that debt creation would ease the impasse by expanding demand and creating new markets. In mainstream economics, finance and debt creation are viewed as a lubricant that helps convert savings into investment and capital formation. This lubricant is sometimes compared to the oil in a car engine. Keen accepts that debt creation for investment is useful, but he finds that during prosperity, private debt, rather than functioning as oil in a car engine, plays the role of gasoline in a car engine. Private debt creation is essential in propelling the economy forward. Except for World War II, government debt creation has never been big enough by itself to create enough demand.
At the conclusion of World War II, the private debt of the U.S. was equal to 45 percent of our gross domestic product (GDP). Right before the current crisis began, it was equal to over 300 percent of GDP! From 1945 until the current crisis, private debt would increase or decrease about 5 percent annually. In the current crisis, private debt fell by 25 percent in one year! That decline in private debt was worse than during the Great Depression and it created a sharp drop in demand resulting in a steep rise in unemployment.
Because each 1 percent of unemployment adds $100 billion to our deficits (the unemployed give no revenue to government, but they create plenty of expenses), for the first time, the U.S. regularly had deficits of over $1 trillion a year. The growth in deficits is entirely attributable to the shrinkage of private debt, since the growth of employment is 94 percent dependent on the growth of private debt.
Keen is not surprised that Federal Reserve efforts to expand private debt by lowering the interest rates to historic lows have until now failed. He argues that historically, private debt is often created without government or the Federal Reserves. In the 1800s, when there was no Federal Reserve, there was plenty of private money and debt creation. To the extent an individual could get others to accept his IOUs, he could create his own money, without any government involvement.
Although Dennis Kucinich had Keen brief Congress on Dec. 5 2012, most economist and national leaders will probably have a blind spot regarding the importance of private debt creation for a long time.
Keen has marshaled enormous empirical and theoretical evidence for his theories, yet if they are correct it has profound and disturbing implications for the U.S. and the world. He is saying private debt creation is essential for economic growth and increasing employment and deficit reduction. But he is also saying private debt cannot grow forever. Overcoming this dilemma is a central challenge of the future.
Jones lives in West Haven.