Economic Populist: The Real Deficit Crisis

Burning the Midnight Oil for Populist Economics

This is something that you are never shown when anybody raises the "debt crisis". Total debt in the United States compared to total US GDP.

Steve Keen marks the level of total national private indebtedness which has been associated with Great Depressions in the United States and in Australia. We are fortunate here that Steve Keen is an Australian, and can look back beyond just the Great Depression of the 1930's, which we had in common, and can look to the Panic of 1893 and the following Great Depression of the 1890's, which we also had in common. However, we don't have the data in the US for the 1890's, because in the US in the 1890's we operated under "wildcat" banking. For practical purposes, we continued under a modified form of wildcat banking after the establishment of the Federal Reserve System, through to the establishment of the Federal Open Market Committee by act of Congress in 1933.

If we think about it, during the period of Wildcat banking, we had three "industrial" depressions in 60 years. In the 1800's what it was that was "depressed" was different for different observers, so we have both Industrial Depressions and Agricultural Price Depressions. And the wave of exported agricultural commodities from the United States, first and foremost, led to a sustained Agricultural Price Depression from 1893-1896 often referred to by historians as the "Long Depression".

The "Long Depression" had it its bookends two clear Industrial Depressions. The first was the Great Depression of 1873-1879, the longest single sustained downturn in GDP in our nation's history (the single block of grey in the US Bureau of Economic Analysis economic downturns in the . This was similar in many ways to Japan's Lost Decade and what many of us fear is going to turn out to be the Austerity Hysteria Depression of the twenty-teens, it started with a severe financial crisis, the Panic of 1873, and a severe economic recession, and then the recession dragged on in a period of economic stagnation that did not end until recovery began in 1879.

The "Great Depression of the 1890's" was more similar to the Great Depression of the 1930's ~ two recessions in a row with a weak recovery in between. The first severe recession was set off by the Panic of 1893. In an area of wildcat banking with Gold Reserves playing a central role, a key element of the ending of the Great Depression of the 1890's was the Klondike Gold Rush.

Of course, the Great Depression of the 1930's being not only more recent but also the deepest economic downturn in US history, and a Depression that once could not escape by turning to subsistence farming on the now-closed Frontier, has largely wiped the memories of these earlier Great Depressions from our minds ~ something which the clever spin-masters take advantage of when they explain how the New Deal was somehow responsible for extending the Great Depression and if only we had done nothing ~ as in the 1870's and 1890's ~ everything would have been sunshine and light ~ as obviously was not the case in the 1870's and 1890's.


But Wait A Minute, What About Government Debt

Anyway, thanks to the Australians experiencing Depression conditions in the 1890's and 1930's, as did the US, we have three observations of what happens with private debt and depressions, not just one.

And what happens is that a surge of debt reaches a point where there is a massive financial crisis. That massive financial crisis leads to a downturn in GDP, at first increasing debt as a percentage of GDP (that is, the bottom of the fraction gets smaller, making the percentage bigger). But then there is a wave of bankruptcies and the unsustainable overhang of private debt is knocked back down to a sustainable level.

The sustainable levels seem different for the US and Australia, closer to 100% in 1890's Australia, and to 175% for the Great Crash of 1929 in the United States. Indeed, I would suggest that the reason that the Australian level of private debt was no larger than it was in 1929 was that the contributions to the defense of the British Empire in 1915 to 1918 slowed growth in Australia, and so Australia primarily "imported" its participation in the Great Depression of 1930 via collapse of export incomes. But all that changes is the timing of the collapse: if not for the roar of the Roaring 20's in the US, perhaps the rest of the world may have been spared a Great Depression until the middle of the 1930's.

And ... government debt? What the hell difference would it make, unless the government debt was owed in a foreign currency? As long as US government debt is owed in US dollars, and Australian government debt is owed in Australian dollars, those dollars can be created at the stroke of a pen and strike of a keyboard. In the US case, this is via the decisions of the meeting of the Federal Open Market Committee, followed by actions of the technicians that carry the decisions out.

You'll hear a lot about government "borrowing" ... but its all confusion or misinformation. If the FOMC is maintaining a particular interest rate, and the Federal Reserve auctions treasury bills or bonds on the open market, that drains reserves from the system. Maintaining the interest rate requires restoring those reserves, which the FOMC does by ordering Federal Reserve Banks to buy bonds. And after a fairly small amount required to run the Federal System is deducted, all the surplus interest payments on bonds held by the Federal Reserve Banks are returned back to the Treasury.

Which is the functional equivalent to selling someone an IOU from your right pocket in return for money, and then using that money to buy that IOU back again, putting it in your left pocket. Its not a real obligation unless its out in circulation.

Actually, the same thing if the government "retires debt": the government pays the bond holders for their bonds. That pushes reserves into the system. Maintaining the interest rate requires draining those reserves, which the FOMC does by ordering the Federal Reserve to sell bonds. So even though the bonds are "bought back from the public", the public ends up holding about the same amount of bonds, and its the Federal Reserve that has reduced its holdings.

Which is the functional equivalent of passing that IOU back from your left pocket to your right pocket, except you force yourself to play a game of first buying an IOU from a member of the public to put in your right pocket, and then selling one from your left pocket.

And even those are based on rules that the government imposes on itself. When something is a serious emergency ~ not over 10% of the nation's available labor hours and productive capacity unemployed, but a World War that makes wealthy people afraid for the security of their real property and persons ~ the rules are easily changed to allow the Federal Reserve Banks to buy bonds directly from the Treasury.

So when you hear about a debt crisis, you will be hearing about more Kabuki Theater being played out in Washington DC. But what you won't hear about is the massive private debt burden in our economy. The same massive private debt burden that in the 1893 led to a massive financial collapse leading to a Great Depression, in 1929 led to a massive financial collapse leading to a Great Depression, and in 2008 led to a massive financial collapse ... which may or may not lead to a Great Depression, depending on whether we let the Austerity Hysterics insist on repeating the actions of the past in order to repeat the lessons of the past.


Message from Marley: Buffalo Soldier

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Thanks for this reminder/exposition about the fraudulent crisis

Tyree's picture

And no, since much of the Democratic Party also buys into the Hooverist deficit fraud, I think the sad fact is that we are very likely to experience that Depression this time around as well. All the structural indicators are pointing to it. A consumer-driven economy with a declining middle class and a recklessly lax regulatory culture is not going to weather another pending recession, given, as Roubini notes, all the main responses used this last time are now not available for the next round.

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Muddling through is a possibility ...

BruceMcF's picture

... which is like the period between the bookends of the Great Depression of 1873-1879 and the Great Depression of 1893-1896 ... a stuttering economy with periods of recession often not much shorter than the periods of recovery, except without the ability to go off and steal another forty acres of lands from Native Americans as an escape valve.

Muddling through depends on there being at least one engine of growth turning over at a time, much as it has been since the end of the 2007-2009 recession, with short period of pent up business investment and consumer durable product spending, then strong export growth as that faded out. That strong export growth was directly or indirectly depending primarily on China and South America not engaging in Deficit Hysteria Austerity.

So, maybe Europe kicks the can down the road far enough that the adults are able to wrest control from the childish "serious people" who are presently running things on false myths and empty slogans. And maybe that happens before things go pear-shaped in China. And maybe the real estate industry in the US starts to work out where the money is and behind the scenes start forcing state governments to support infill development around transit corridors (because few state governments can stand up against the big property developers for a sustained period of time) ...
... but its all very much a Goldilocks scenario, and Goldilocks scenarios are long odds things.

The short odds are that, since we failed to tackle the balance sheet problems when we had the banks by the short and curlies, there's going to be another crisis in the next year or two, and because the balance sheets of our banks are still screwed up, we get to have a second massive financial crisis and a double dip recession. And in one of the few major political races where there's a ray of hope, I do seriously hope that Elizabeth Warren is in Senate if that happens. We will need her voice.

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Of course they do ...

BruceMcF's picture

... the Hedge Fund wing of the party believes it hook, line and sinker, and the Democratic wing of the party is afraid to call bullshit on it because the Mess Media will call them wild eyed crazies.

A progressive populist movement can't be afraid to call bullshit on this nonsense, and if that means that the movement has to be built on the outside of the established wings of the party that has a relative handful progressive and populist members (and outside of their established media organs, whether they be OldMedia or NewMedia) , well, so be it.

Its only four more years to 2016, so there isn't time to waste on worrying about the different wings of the Corporate Party fighting over whether we get a Tory Corporate President or a Whig Corporate President.

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Well said Bruce.

nemesis's picture

I always wonder why we allow this charade to continue. The fed is just a money printing operation. If it wants less economic activity, it prints less. If it wants more activity, it prints more.

This used to be taught in school, learned it myself in 7th grade.

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Not exactly ...

BruceMcF's picture

... banks create most of the money in the economy. What the Fed can really control is the short term cash rate that they decide to target.

The macroeconomic chapters that I have seen and have had the wonderful opportunity to teach to students why its a load of nonsense take the reality of banking operations, and then pretend that banks have only one kind of deposit account, and so have no freedom to manipulate their rate of required reserves in those cases where the Fed starts to fantasize that they can control the size of the money supply ~ as the Fed fantasized during much of the 1980's. But all you need is check accounts and certificates of deposit, and the theory of the Fed controlling the size of the money supply falls apart.

So certainly when the government spend its the same as creating money (and when it taxes, its the same as destroying money), but that is in the context of the banking system creating the bulk of the money that we use in the economy.

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Keen insights

priceman's picture

Private debt is the dangerous debt. It's a chain around consumers' neck. I love the insight into the long depression and the differences via price depressions you mentioned before. Despite economist Irving Fischer's misdiagnosis of the bubble leading up to the 1929 crash(thinking it was going to go on and on), he learned from his mistakes and taking in what you mentioned came up with the definitive analysis you mention and what Steve keen and other post Keynesian put into their models via debt deflation 101. Not everyone understand this, but this is what is truly the message in this Occupy piece i did.

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In fact, Steve Keen has ...

BruceMcF's picture

... talked about the "Great Moderation" that led to people thinking that the business cycle had been tamed in both the 1920's and the Turn of the 21st Century, that it is an indicator that debt is becoming unsustainably high to the point of representing an immediate systemic risk.

Basically, if there is so much debt out there that playing a couple of games with juicing up the bubbles at hand have enough impact to basically let us ride out a recession on that alone ... we have way too much debt, and are already over the edge of being into what Minsky called a "Ponzi Finance Economy". And once we are over that edge, the question is not whether a massive financial crash is coming, but only when and where will it first hit.

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Private debt burden caused by

aigeanta's picture

lack of real wage growth while the cost of living, especially health care and housing, grew practically exponentially, with bubbles frequently engineered by financial elites who would profit quite handsomely. Meanwhile all investment in the business of the common man has ceased, due to unrealistic and arbitrary credit thresholds, and usurious rates manipulated by fraudulent banking institutions.

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Or turn the lack of real wage growth around ...

BruceMcF's picture

... debt as a percentage of GDP growing because debt is created, created new purchasing power, and then instead of that going to grow the economy, it gets skimmed off by the 0.1%.

We still had debt fueled growth in the 1950's when there was no explosion of private debt ~ but when the debt buys real productive capacity, and helps put that productive income to work, and grows not just "average" GDP but actual middle incomes ... then the GDP grows as well. Creating debt to put wealth in the pockets of "a loose association of millionaires and billionaires" ... that ensures that debt grows faster than GDP.

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Usury Laws

sartoris's picture

Spot on comment. Usury laws need serious reform.

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Consumer Debt and Bankruptcy Law Revisions

sartoris's picture

This crisis has been building for about 30 years. The stagnation of wages coupled with destruction of American manufacturing jobs has created a never ending debt cycle for millions and millions of Americans. It's easy to tut tut and blame those who end up in debt but when the underlying causes are seriously examined (lack of health care, lack of wage growth) it's clear that debt is the symptom and not the disease. When the personal bankruptcy laws were rewritten it was for the sole purpose of creating indentured servitude. Bankruptcy laws are slanted in the favor of corporations in a manner that has never been seen in American history. The coming student loan debt crisis will keep a generation of Americans in debt for the vast majority of their working lives.

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