Ask The Expert - Steve Keen - November 2016

Transcript:

Narrator: You are listening to Ask the Expert on Sprott Money News.

Craig: Well, hello again everyone and greetings from sprottmoney.com and Sprott Money News. This is your Ask the Expert segment for November of 2016. I'm your host Craig Hemke, and joining us this month is economist Steve Keen. Steve is a professor at the Kingston University in London and he's also the author of the upcoming book "Can We Avoid Another Financial Crisis," which is due out in the spring of 2017. Steve, thank you so much for taking some time to join us here at Sprott Money News.

Steve: Well, lovely to be here.

Craig: Again for everybody listening, these are questions that have been submitted to the Sprott Money blog for the guest. So these are straight from the customer base of Sprott Money and if you're ready, Steve, I'll begin to roll them on.

Steve: Yes, let's roll away.

Craig: The first question has to do with debt and the preponderance of global debt at really all levels. There are some moves of quantitative easing to take some of that debt upon the Central Bank balance sheets. The question that was sent in from John just wants to know how eventually will all of this debt unwind? And to you, what is the most likely outcome?

Steve: Yeah. Well, it is a globally unprecedented level of debt. The combination of both private and public debt really I don't has ever been seen in human history before. Now, the biggest previous debt bubble was, as you said, during the Great Depression. And looking so at private debt alone, when you normalize the data just so that the data collect these in different ways in different time periods coincides for the way we most recently defined debt courtesy of the definition the Federal Reserve uses for private-sector non-financial debt. So the sum of household debt plus business debt, that peaked during the Great Depression at about 140% of GDP. It peaked this time at 170%. So uncomfortable figures.

We're carrying a higher level of debt than caused the Great Depression in the private sector. And then at the same time, we have a level of government debt which in characteristic terms is very different to private debt because the government is the only organization on the planet that owns its own bank. That has to make a difference somehow. But the combination of the two where we're talking global levels of debt for quite a few countries running at the order of 400% of GDP.

Now, the way this has normally been resolved in the past is we blow each other up. Quite frankly, it leads to global wars. You can find so many conflicts in the past, most obviously the second world war, where you can directly relate it back to the impact of, first of all, a debt bubble causing a boom in America in the 1920s, the roaring 20s were the first precursor of the 1990s stock market bubble. That drove debt to huge levels. We then had deleveraging and deflation during the Great Depression that drove the ratio even higher. Even though debt fell, the ratio of debt rose. And that led quite directly to the rise of Hitler in Germany because, just in that particular case, the German government had sold a lot of bonds to American investors. And one of the first things the Nazis did when they came to power was write that debt off. Now, that actually stimulated the German economy dramatically. They also bought the debt off when it was at bargain basement prices and then repurchased the ownership just to be sure anyway. But that was a huge part of the growth of the industrial power of Germany and the lead-up to the second world war of course.

Then the second world war and in turn America's case, when that war began, the level of private debt had been reduced by deleveraging and by bank debt write-offs and by the bank holiday that Roosevelt announced where lots of the debt was written off the books during the bank holiday, that level of private debt had been driven down from what it was at the time of the--this is 1933, beginning of the crisis--to about 80% of that level. Now, what actually reduced the debt down to trivial levels and gave us a boom, the post-war boom, was the second world war because the debt then fell from the 80% of its debt level in 1930 down to 35%. So we had two-thirds of the debt that had caused the bubble and the bust of the 1930s written off through the process of the second world war and then the great long boom began after that.

So that's the way we resolved in the past. Now, we can't afford a third world war. One of the little problems, we weren't able to wipe ourselves out, we weren't able to destroy life on the planet in four previous wars. This time we can do it, so we don't want to use that particular solution. But with that as the only way out, we've actually successfully got out of it in the past, the only really successful way to get rid of this debt is to write it off. And I'll quote my great friend Michael Hudson on that. My friend Michael once made the comment that "Debts that can't be repaid won't be repaid." I've added the footnote that all you've got to do is work out how you're not going to repay them.

So the way it's been done in the past is by violent conflict and then by...basically when you've blown up the banks, it's no longer possible to keep records of debt. We have to find a way of writing it off. Otherwise, it'll stick there and...this is the great danger. Japan had its owned debt crossed as well before America had its 2007 crash. Its debt crisis began in 1990. At that stage, government debt was down to about 60% of GDP and private debt hit something of the order of, at the peak, 220% of GDP. The government debt has then gone, as we all know, from about 50% of GDP in 1990 to almost 250% now and that's what everybody focuses upon. In the meantime, private debt's come down from 220% to about 175% but the aggregate level of debt has risen overall. So Japan's now sitting on about 400% of GDP is its debt level.

Now, we would like to grow out of that, okay? That would be the nice way to do it. It would be nice to inflate our way out of it. When you look at the historical record, the only times that we've ever grown out of that much debt is if there's been a huge inflationary surge of some sort which occurred in the 50s, 60s, and 70s in America to reduce the level of government debt to GDP. Or there's been some gigantic export bonus which...for example, Saudi Arabia managed to write its debts off when oil prices rose as much as they did courtesy of all the OPEC price wars. But in all the other cases...and this is working on research from Richard Vague who's the American philanthropist running the debt-economics blog and campaigning for the debt evolution through the banking sector, we've only ever written a debt off by literally writing it down. It's been accounting operations that have got rid of it.

Now the trouble is, if you delay those accounting operations, then what you get out of it is the debt burden is so great that it stops people investing and stops them borrowing for consumption. You get very loaded negative credit demand and you remain in a long-term slump. And that's the situation Japan has been in now for 25 years. And politically, there's no way that America can cope with the same.

So my feeling is that this is the sort of thing that leads to political overthrows and political breakdowns. And we're seeing that happening in Europe right now. Trump's election clearly has been driven by this. I'm really...my trouble is that I...there isn't a simple economic solution to it. It involves finally writing the debt off but that is such a huge change in how we think about debt that it may be delayed indefinitely. And in that situation, we're going to have stagnation and political conflicts. That's, unfortunately, the only future I can see.

Craig: In the meantime, is that inflationary, deflationary, a little bit of both?

Steve: Well, if we wrote the debt off, it would be inflationary in a very, very simple way. And this is what I'd like to see happen because the reason we get ourselves caught in these debt traps is we don't actually realize how easy it is to make money. Now by saying it's easy to make money, I don't mean it's easy to make a profit. I think it's easy to create money if you have the right to do it. Banks create money by lending out more than they get back in repayments. It's simply a kind of double-entry bookkeeping.

If they're issuing more loans than they get in repayments, they're creating money in the process. Governments create money by running a deficit, and the government can do that when it uses its own money for...actually the European countries can't do this because of the Euro. But America and England can do it because they use their own currency. So effectively, in the long term through all the various machinations that are involved in government finances, effectively the central bank can finance whatever the government wants to run as a deficit. It doesn't need to add tax to get the money, it simply has the capacity to print the money.

Now, if the government used that capacity to inject money into people's private bank accounts on a per capita basis and then said, "Anybody who's in debt has to pay the debt down, but anybody who hasn't got debt gets a cash injection," that would be inflationary. It would reduce the debt levels. And in that particular case, people thinking about gold, of course, it would be good for the price of gold which would go up in the process. But we could reduce the debt simply by a couple of accounting shifts.

Now, there'd be all sorts of devil in the detail there, all sorts of loan covenants that mean that even paying your debt off more quickly as a real reason to breach the loan contracts, all the off-book, off-balance sheet debt that exists or all the securitized debt. It's an absolute swamp we've created out there...with this talk about draining the swamp, that's probably the biggest swamp of all.

But so that could be done, and if it was done then we'd get out of the crisis in a relatively easy way. We would cause inflation. It would be good for gold in terms of the leverage of price of gold but that involves people getting a level of awareness about the money system, which the last one and a half centuries have found we're pretty good at not getting. So I'm not particularly optimistic about the chances of it happening.

Craig: Yeah, that's a good point. That is kind of a good segue to the second question that was sent in, Professor Keene. That comes from a gentleman named Jeffrey who just simply wants to know would Warren Buffett be considered to be as rich and as successful as he is today had Richard Nixon not put an end to the gold standard 45 years ago?

Steve: Yeah, I think he probably would because it wasn't so much the gold standard or floating money levels that Buffett was exploiting. He was pretty much exploiting the nonsense theory that economists deluded themselves. We'll call it the efficient market hypothesis. And that said that shares currently contain all the information about the future price, the future earnings of share companies. And therefore they are realistically priced. And basically, Buffett's reaction to that was to say, "What have you been smoking recently? I didn't know it was legal back in the 1950s." And said, "If you believe that, I'm going to bet against you," and what he did was start looking for shares which were being ignored by the market.

My favorite comment from Buffett in one of his many newsletters was during the dot-com bubble. He said that, "Your company Berkshire Hathaway has purchased a vitamin manufacturer and a soap company. Try to restrain your enthusiasm." His point was that these was just because these weren't dot-com companies, the market had undervalued them. Their cash flow and their revenue was extremely high. They were, therefore, likely to rise in price over time and they were returning a good dividend stream anyway. That's the sort of business he bought.

Now, according to the Efficient Markets Hypothesis, those companies didn't exist. Theory said that if you purchased shares with a higher return, you have to put up with a higher volatility. But Buffett was counting on the fact that this was based on an economic fantasy that there was a positive relation between risk and return which ignored the capacity of the market to get caught up in what they call growth stocks. And believe and therefore bid up the price of their stocks in the belief that they would have even higher returns in the future. And almost all the growth stocks were effectively the herd chasing off in a collective direction, overvaluing their shares. And therefore they'd underperform in the future and they, therefore, correct in the medium term.

So that was mainly the strategy that Buffet has used to great effect. And that's why he's become so wealthy. The gold standard is a bit of a side if it would have been a minor hiccup for him in continuing to exploit the conventional thinking that dominates most other share placements.

Craig: Fair enough. The next question comes from Bob and it's about as straightforward and as simple as it can get. It's only about six or seven words. Is the Trump presidency good for gold?

Steve: I actually think it's actually going to be bad for gold but good for the economy. Because what Trump is going to do...it's obvious that he's going to do tax cuts and there's going to be no opposition of the tax cuts. The Democrats might scream about them going to the wealthy but he'll get them through with the backing of the Republicans. At the same time, you think about Trump's personality and what he does, he loves buildings with his name on them, which I think goes down in the satirical world as having an Oedipus complex.

Now he will go on to build infrastructure all over the country. He's had Trump buildings, he had Trump airlines, so I think he wants Trump Airports. It's not that they necessarily be called that while he's alive but I'm sure he hopes they get called that after he's passed on. JFK Airport, we've got also with LBJ Airport, etc. There are going to be lots of Trump Airports around the country. And Trump Roads, and Trump this, and Trump that, and that is going to be a huge boost to government spending.

Now, of course, the Republicans are likely to try to block that and say, "No, you can't do that, that's going to give us a budget deficit." I think Trump's quite a pragmatic character when it comes to things about budget deficit. And so he's going to say, "Does this increase employment? Does this boost the economy? We'll handle the financing of it later." I think what we're going to see is a huge government deficit, and that's what the country to some extent needs frankly. A huge deficit, huge infrastructure spending, cut back on taxation, huge creation of government money stimulating all the stuff. I think an economic boom is going to occur.

The usual reaction to that when America has a boom is wanna buy the American dollar and get into the party. If they buy the American Dollar, they're going to be selling other assets. Of course currencies, but also gold. So my expectation is you're likely to see...and I could be proven wrong on this one, this is very much a speculation. But I would expect that if the Trump presidency has the impact on the economy that I think it's going to have, at least in those first four years, then we're going to see gold price falling.

Craig: All right. The next question comes from Richard. This one's a little bit different. With population growth exploding around the world the past few decades, and industrialization, and modernization, and better health care, all those things playing a role, what do you expect going forward in terms of how that will affect the global economy? Is population growth good for the global economy, more jobs, more economic activity? Or is it bad for economic activity because of looming disasters, environmental disasters, things like that?

Steve: Yeah, I mean, this is one of those areas where, particularly given that a lot of people who vote for Trump are cynical about everything including NASA, an idea of cooking the data...that people saying are saying that there's no particular problem going on, etc, etc. It's all being invented by bad data. I'm just not going to even engage with that argument. I just...if people believe that you can't get anywhere.

So what I'm going to look at is an interesting piece of research done by an academic some decades ago called the "Global Ecological Footprint." And what he did was there to say, "Okay, how much land area does it takes to support an individual human being? And how does that land area compare to the amount of land you've actually got?" And of course, it's pretty obvious to map across from our need for wheat to the amount of acreage for wheat. But it was rather more complicated to map for things like our need for cars to the acreage taken up by a car factory. But in doing the calculations, he came up with this number that you could then convert how many people have got what their standard of living is and what the resources of the country they're in are to what burden are we putting on the capability of the planet to reproduce itself every year.

And on that basis he said we're pretty much consuming in terms of its capacity to regenerate itself every year, about 1.5 earths. Now, that ain't sustainable. And we've been doing it...we're getting more and more extreme in that calculation for the last 20 years. I think we've passed the point where we're using a sustainable planet a year between 1995 and 2000. So clearly we can't keep on doing it. And population is part of the factor. If you can...people who have got a left wing orientation will say you shouldn't say it's population swell. I'm sorry, it is part of the issue where you needed to reduce our population burden as well as the living standard burden.

So I think we are seriously in overshoot in the capability of the biosphere to support the lifestyles we currently have. And we have to backtrack. So in that sense, I'm somebody who thinks we should be targeting reduced population. There's too many humans on this planet, we're putting too much of a load on its biosphere.

Craig: I've got two questions left for you, Professor Keen. And the first one has to deal with global housing. No doubt during the kind of boom years of the early 2000s, we saw global housing prices spike all the way through 2007-2008. But now they've been rather stagnant since. What are your short and long-term projections for global housing prices?

Steve: Yeah. The basis of what drives housing prices...it's a slightly complicated argument. But the basis of what drives housing prices is actually accelerating mortgage debt. Now that sounds weird but I'll let that one hang for a second and explain why. If you think about that people use the supply and demand framework to understand these things then they ignore demand, I use it and I consider demand. So you mentioned that what's the supply on the housing market? It's the flow of the percentage of existing houses that are sold each year. So that depends upon the stock of housing and what proportion of it is put on the market every year. And that varies, it goes up and down but that's one element, plus new housing being constructed. That's your flow of supply.

Your flow of demand is really driven by mortgage debts. And new mortgage debt, which is a change in mortgage debt, you divide that by the price index, that's like the flow of physical demand for physical numbers of houses. Now if that flow of demand is greater than the flow of supply, you're going to have rising prices. So you've got a relationship there between the change in mortgage debt and the level of house prices. That gives you a relationship between the acceleration of mortgage debt and the change in house prices.

So what's driven house prices high, this was the case in America in particular, was the rising house prices when mortgage debt was accelerating. Now, nothing can accelerate forever. It reached a peak level, I think back in about 2005-2006, of the acceleration. Then you had the rate of growth of mortgage that's starting to grow but grow more slowly, that's when the house price fall began. Now we then had about a 20% fall in mortgage debt as a percentage of GDP. It's now started to flat-line and started to rise again, which is giving you acceleration once more. So I expect to see House prices continuing to rise in America courtesy of that acceleration effect. And Trump's presidency is likely to add to that too, I expect because people will get back into the housing market if the economy starts to appear to boom.

But in the rest of the world, you've got countries like say Australia and Canada who've continued pushing up their house prices by continuing to drive more and more mortgage debt into the economy through this acceleration trick. And they've now got levels of mortgage debt of about 1.2 times GDP. And to give you an idea how that compares to America when it's crisis occurred back in 2007, total private sector debt then was 1.5 times GDP. So you're talking about mortgage debt alone being 1.2 times GDP. Canada and Australia are both carrying about 2.1 times GDP as their private debt level right now. They've got to tank. And when they tank, their mortgage debt's going to go into reverse and those house prices are going to fall.

But the global bubble, it's varying all over the planet. The countries which have already been through a crisis had a bit of deleveraging and recovering, they can have house price rises going on for a while. That includes England and America. Countries like Australia and Canada which got through the crisis and continued having highly accelerating house prices, they're going to have a crash. China is going to have a crash in house prices, they're off the scale. Hong Kong is already having that house price crisis.

So the global pattern is mixed by the stage of the debt dynamic of which those different countries are. But fundamentally the whole thing is driven by leverage. And of course, now that we're reaching basically peak leverage everywhere, then I think ultimately that tendency for accelerating debt to drive up house prices is going to disappear. So I think we're reaching a plateau in house prices at the global level which is likely to come down in future.

Craig: That's very helpful. Thank you for that. The last question, Professor Keen, comes from a guest using the initials J.H. And he wants to know, you know, there's always this talk about gold as protection against a fiat currency collapse. Obviously, money has to be devalued and created to service all this debt, at almost an increasing rate. Why is it that gold is considered protection against fiat collapse or fiat devaluement?

Steve: Yeah, well there's two great...I mean, a lot people regard gold as substantially what money essentially is. I think they're wrong. If we look back at the empirical, historical record, you find the only times that gold and silver have been used by weight rather than as something which has a king's face stamped on it and the king's valuation rules rather than the weighed...assayed level of gold and silver inside the objects, the only time the actual physical gold or physical silver has been the dominant form of commerce was when you had huge wars like one Hundred Years War and the Thirty Years War, those two separate huge wars in Europe. In that situation, mercenaries would fight for a king only if they were paid in a substance that didn't depend upon the king winning the battle. So in those situations, gold and silver became money. So total social breakdown, then they took over.

But generally, money has been the promise to pay of a trusted third party. Whether that's a government you have to trust because they are the local rulers or banks you trust because they're the local financiers and issuers of debt. And what gold tends to be when you have a financial crisis--and capitalism, its whole history has been a sequence of different financial crises--when those crises hit, people want to take their money out of the monetary system and put it in something safer. And in that sense gold, because it can't degrade, becomes the ultimate hedge against a fiat currency. Not necessarily one that's going to collapse but one that's in big trouble. So what you saw during the aftermath of the financial crisis in 2007-2008 was several periods where people were really worried about the viability of the financial system and bang, up goes the gold price.

Now, the one reason I expect the gold price to fall under Trump is there's going to be so much economic activity generated, even if that does give you a small amount of inflation which it possibly will, it's likely to see people's confidence in the American dollar improve. And in that confidence rising, they'll be trying to buy into the American dollar and selling out of gold. So I think the price is likely to fall.

Craig: Very interesting information, Professor Keen, and I really very much appreciate your time. I do want to throw on a plug for your new book, though, and that might just kind of answer the last question that I have in that your new book that's coming out next year is titled "Can We Avoid Another Financial Crisis." So lastly Professor Keene, can we?

Steve: It could be a one-word book but it's 25,000 words, fairly short. And that's actually the format with the publishers that I rather like, a short punchy book. The answer is no we can't because it's already baked in within all these debt dynamics but it's not in the usual suspects. We normally expect America and England and Europe to be the center of the financial crises. In fact, it's the countries that avoided the crises back in 2008 who are going to have one in the future. And they avoided the crisis by continuing to borrow. So like I've already mentioned Australia and Canada on that front. Another country on the list is South Korea. This is all using data that comes out of the Bank of International Settlements and data that's only been available really for the last one and a half years, which gives us a pattern of private and public debt across, I think 41 countries around the world.

So I've taken a look at that and I've then identified between 9 and 16 countries that have got the two triggers that I see as setting up a debt crisis. One is your level of private debt is greater than 1.5 times GDP, and of course, that's the level America had when its crisis began. And the second is where credit, which is the change in debt, is equal to a 10% or more of GDP on an annual basis. And therefore with that much credit demand being part if your base demand, a slowdown of the rate of growth in that is enough to cause a crisis
So that gave me nine prominent countries. The most obvious ones are Australia, Canada, and China, but also on the list are countries like Norway and Belgium. And also there's a possibility for some of the East Asian countries to end up on the same list as well. So from my perspective, South Korea's in there quite strongly. I also expect to see Thailand, Singapore, and Malaysia possibly having troubles. But there are other countries like Indonesia, which is nowhere near having a problem, Germany is not going to have one. And America and England have already had theirs, they're going to have stagnation rather than a crisis.

Craig: Interesting. I look forward to the book, it sounds fascinating. Professor Keen, thank you so much for spending some time with us here at Sprott Money News. This has been tremendous.

Steve: You're welcome, Craig.

Craig: And from all of us at sprottmoney.com and Sprott Money News, thank you for listening. We'll talk to you again next month.