Posts Tagged ‘Steve Keen’

Will Australia’s own pump-priming work?

Tuesday, October 14th, 2008

As you have heard in the news by now, Australia’s Prime Minister Kevin Rudd announced a AU$10 billion stimulus plan. This is partially reminiscent to the US stimulus plan sometime at the beginning of this year, when the US government sent free money to American taxpayers and called them tax rebates. Rudd’s plan includes money for families, retirees, homebuyers and jobs training and infrastructure projects.

Will all these work?

Before we answer this question, let us consider the relative scale of the problem. According to Professor Steve Keen, Australians’ increased debt last year added $250 billion in spending into the economy. Currently, Australia’s credit growth is decelerating very rapidly. Should credit growth stagnate (or worse still, contract), this $250 billion (or more) in spending will go up in smoke. Therefore, a $10 billion stimulus is actually very minuscule compared to the potential loss in spending by Australian consumers when they are stretched to their limit in taking in more debt. Since most of the Australian economy is made up of consumer spending, such a severe contraction will have a very acute repercussion for the Australian economy. Recent data suggests that Australia’s total private data to GDP ratio is standing still at 165%.

There is no way the government can take up the slack left by the Australian consumer without turning the budget surplus into a deficit that is ten times its size (i.e. turn $22 billion surplus into a $250 billion deficit). But to keep Australians spending as before, they will have to accrue even more debt. There’s no way this increase in debt relative to income can go on forever without turning the entire nation’s economy into a massive sub-prime economy. When that happens, the inevitable blow up in debt bubble will be far greater.

By now, you should appreciate the magnitude of what the government and RBA are fighting against when you consider the scale of the coming deflationary force.

Real economy suffers while financial markets stuff around with prices

Thursday, October 9th, 2008

In yesterday’s ABC 7:30 Report, Associate Professor Steve Keen commented that in the context of today’s global financial crisis,

Well I think Kerry I can actually make a reference to what’s happened to the Australian dollar say every price you see is crazy.

There is no way the prices of anything make any sense at the moment.

Prices in the financial markets are extremely volatile right now. Even prices of commodities (e.g. base metals, oil), gold and silver are moving much more rapidly then we expected (remember a few weeks ago when gold rose by almost US$100 in 2 days?). Currency exchange rates are also very extremely volatile, as we witnessed the fall of the Australian dollar from around US$0.97 to US$0.64. It was just a couple of days ago when the Aussie dollar was around $0.73. Now, at this time of writing, it is US$0.70.

Such volatility and irrationality of prices, if sustained over a much longer period of time, can eventually damage the economy structurally. To understand why, consider what we said in The myth of financial asset ?investments? as savings,

… saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization.

The accumulation of capital goods requires a time lag whereby current consumption is postponed for future benefits. Improved standards of living come to the public from the fruits of capital investment.

For example, producing metals is a very capital-intensive activity. The stages of production includes:

  1. Exploration
  2. Digging large quantities of dirt, which requires expensive, complex and expensive equipment.
  3. Construction of nearby infrastructure (e.g. roads, railways, power stations, development of water supplies and townships) due to the remoteness of mining projects.
  4. Protection of environment, which increase capital and operating cost.
  5. Extraction of ore from dirt.
  6. Processing of ore.
  7. Refining of metal concentrates.
  8. Shipping and transporting to destinations.

Thus, a mining project from start to finish can take several years. Therefore, you can see that the accumulation of capital goods is long term processes in the economy. As such, all these industrious activities require long-term planning.

What if in the interim, prices are extremely volatile, ‘crazy’ and irrational?

As the late Professor Murray Rothbard wrote in What Has Government Done to Our Money?,

Inflation has other disastrous effects. It distorts that keystone of our economy: business calculation. Since prices do not all change uniformly and at the same speed, it becomes very difficult for business to separate the lasting from the transitional, and gauge truly the demands of consumers or the cost of their operations.

Right now, deflationary forces are acting on the economy while at the same time, central bankers and governments are attempting to inflate. Consequently, the result is extreme volatility in prices. Volatile prices hinder business calculations, which in turn hinders long-term planning.

For example, place yourself in the position of a mining company executive today. Commodity prices are falling precipitously over the past few months as the global economy is staring into a possible depression. At the same time, you know that China and India is still going to demand lots of commodities in the very long run in the coming decades (see Example of a secular trend- commodities and the upcoming rise of a potential superpower and The Problem that can throw us back into the age of horse-drawn carriages). Besides knowing these two basic facts, there will still be great uncertainty in prices as the forces of deflation and inflation battles each other for supremacy, regardless of which forces will eventually win. Will we even be using US dollars to calibrate prices in the future? Who knows? In such an indeterminate environment, it is clear that many more mining projects will have to be shelved. Some have to be abandoned. You may be scratching your head, wondering whether to push forward your project plans.

With long-term planning made much more difficult, how is it possible to engage in investments that allows the nation to continue to accumulate capital goods? Without the ongoing accumulation of capital goods and too much monetary capital wasted on either hoarding, bailing out bad investments and patching a dysfunctional financial system, there wouldn’t be a proper and efficient allocation of monetary capital. The economy will be engaging on capital consumption. If a nation starts to consume its capital, how can there be real economic growth. Without real economic growth, how can future generations enjoy a more plentiful and prosperous existence?

As we ponder on the long term implications of today’s volatile, ‘crazy’ and irrational prices, we saw a sampling of such a phenomenon in one of the news article today, Volatile economic conditions unsettle farmers,

UNDER normal circumstances, an interest rate reduction coupled with a devaluing of the Australian dollar would make farmers very happy indeed.

But not this time, according to National Farmers Federation vice-president Charles Burke.

“There are some other factors at play at the moment that none of us really know how to measure,” Mr Burke said.

“Nor do we know how to deal with it because we don’t know how long it will last.”

That’s why the Austrian School of economic thought advocate a painful deflationary liquidation of mal-investments (read: severe recession/depression) in order to clean out the rot in the system, put on a sound monetary system so that the economy can get back on its feet as soon as possible from a clean slate. But central bankers and governments are trying their utmost to drag on this war between deflation and inflation indefinitely, which means more uncertainty ahead for the foreseeable future.

Interviewing Steve Keen for the upcoming property forum debate

Thursday, September 25th, 2008

In Upcoming forum debate: ?Property 2009: Crash, Boom or Stagnate?!?, we announced that for the upcoming property debate on 15 October 2008, we will be “inviting the various high-profile experts to this debate.”

Today, we would like to announce that Associate Professor of Economics and Finance from the University of Western Sydney, Dr. Steve Keen, will be one of the special guests in this forum debate. For those who have yet to know about him, we have conducted a short interview with him:

***********

What are you currently doing in your line of work?
Currently, I’m revising a paper on how money is endogenously created by the financial system for the journal Physica A- the journal of interdisciplinary physics, where the so called “econophysics” school has evolved.

Once that’s done, I will start work on my magnum opus “Finance and Economic Breakdown”, a book-length development of Hyman Minsky’s “financial instability hypothesis” which will be published by Edward Elgar Publishers.

So, can you share a bit about your life journey that brings you to what you are currently doing?
I began as a believer in conventional neoclassical economics while doing my undergraduate degree and then had my confidence in this theory shattered by exposure to Lancaster’s “theory of the second best” in my first year at Sydney University. This theory, which shows that a move closer to the neoclassical nirvana of competitive markets everywhere may actually reduce welfare, made me aware of the theory’s fragility and I then embarked on my own learning odessey to work out why.

In the process I started the Political Economy movement at Sydney University.

After my student days I worked as an overseas aid education officer, a computer programmer, computer journalist, conference organiser, and then finally was employed by one of the Accord bodies under the Hawke Government. The way the Accord was hijacked by conventional economists within Treasury and the bureaucracy in general convinced me that I had to return to academia and take this nonsense theory on on its home turf.

That led to the publication of Debunking Economics, which was commercially successful, and made me a prominent member of the non-orthodox fringe of the economics profession.

It has been noted that your viewpoints on economics are very much different from the mainstream economics. In a nutshell, can you explain how and why they are different?
I reject the equilibrium modelling that dominates conventional economic analysis, and since I did mathematics as an undergrad and postgrad student, I knew how to apply nonlinear dynamic modelling methods to economics–basically using Differential Equations and Systems Theory. I also use Hyman Minsky’s “Financial Instability Hypothesis” as my fundamental model, supplemented with lashings of Schumpeter and a unconventional reading of Marx.

What is your stand on the current state of Australia’s debt levels?
We have reached a level of excess that is historically unprecedented–literally twice the level (compared to GDP) that caused the Great Depression. I have zero confidence in our ability to avoid a serious downturn as the great de-leveraging begins.

***********

We will have another special guest for this forum debate. We will reveal who he/she is next week. Keep in tune!

Property 2009: Crash, Boom or Stagnate?!

Is this the beginning of the loss of confidence in fiat money?

Sunday, September 21st, 2008

Events from the past week are tumultuous. It started from the nationalisation of Freddie and Fannie (we were mulling about the implication of nationalisation 2 months ago in How do we all pay for the bailout of Fannie Mae and Freddie Mac?). Then came the bankruptcy of Lehman Brothers and takeover of Merrill Lynch. Then we have the nationalisation of AIG. Gold prices surged by more than US$100 in two days (it had declined since), which was the most rapid surge in 26 years. At the same time, the Dow plunged by more than 400 points. It looked as if there was a panic from stocks straight to gold, which meant even cash was distrusted.

Then we have another massive rally in stocks for the past two days when there was hope that the US government, in conjunction with the Federal Reserve are doing something to solve the root of the rot in the financial system. Reports come out that they are planning to use taxpayers’ money to buy up bad assets at sale price. As always the case, the devil is in the details. At this point in time, there is no definitive figure on the cost. Make no mistake about this: this is no trivial task. As this New York Times article reported, Ben Bernanke warned the Congressional leaders,

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program ?Good Morning America,? the congressional leaders were told ?that we?re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.?

Mr. Schumer added, ?History was sort of hanging over it, like this was a moment.?

When Mr. Schumer described the meeting as ?somber,? Mr. Dodd cut in. ?Somber doesn?t begin to justify the words,? he said. ?We have never heard language like this.?

By now, it should be clear that this global financial disaster has the potential of even surpassing the Great Depression of the 1930s!

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: “No one could ever foresee this! It’s impossible! Only hindsight can tell!”

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions. Always, only the minority could see through the lie. In this case, students and practitioners of the non-mainstream Austrian School of economic thought SAW IT COMING. Some of them sounded the alarm as early as 2004! To press our point further, let’s us show you the chronicle of our warnings in this blog since 2006…

  1. In May 2008, when the world was in denial about the precarious state of the global financial system, Satyajit Das warned that the credit crisis was just the end of the beginning (see Is the credit crisis the end of the beginning?).
  2. Back in November 2007, if you look at the list of major US financial institutions that was compiled by Nouriel Roubini at How solvent are some of the major US financial institutions?, only half of them are left standing. Interestingly, Merrill Lynch was the safest among the insolvents and today, it failed to live. If Merrill Lynch was insolvent, what about the remaining ones today (i.e. Goldman Sachs, Morgan Stanley, Citigroup)?
  3. In June 2007, in Epic, unprecedented inflation, we warned that

    How much longer will the roaring global economy fly? We do not know the answer, for this boom may last longer than what we anticipated. However, please note that in the entire history of humanity, all bubbles (and we repeat, ALL) burst in the end. Thus, a global painful hangover will ensue?the greater the boom, the more painful the eventual bust. This is the theme that we had repeated many times.

    Thus, do not be surprised if a second Great Depression were to strike.

  4. In the same month, the Bank for International Settlements (BIS) warned that the world was in danger of another Great Depression (see Bank for International Settlements warns of another Great Depression).
  5. Back in January 2007, in Spectre of deflation, we wrote that

    But we smell danger.

    It is a danger in which many in the finance industry failed to fully appreciate?deflation. Such complacency is beyond our belief. In the 1990s, Japan experienced it, with dire consequences for their economy. At least, the ordinary Japanese had their savings to fall back on. For many Americans, with their negative savings rate, what can they fall back on? Have they not learned from the mistakes of others in the past?

  6. In the same month, Trichet, the president of EU central bank warned of a coming asset re-pricing (see Prepare for asset repricing, warns Trichet).
  7. Back in November 2006, in How will asset-driven ?growth? eventually harm the economy?, when the global economy was still booming in apparent ‘prosperity’, we quoted the late Ludwig von Mises (the in which the Mises Institute of the libertarian Austrian School of economic thought is named after) and warned that

    That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

    This is the reason why we believe a recession is on its way.

  8. In October 2006, we quoted the late Dr. Kurt Richeb├Ącher (an Austrian School economist) and questioned in The Bubble Economy,
  9. These are some of the serious questions we would like to ask:

    1. As the US spends its way into economic ruin, its economy is being damaged structurally. How much longer can the US sustain its colossal debt?
    2. Right now, the US housing bubble is deflating. Will it eventually burst and wreck havoc on the rest of the economy?

Other contrarians who sounded the alarm long ago (and we quoted often) include Marc Faber, Jimmy Rogers, Robert Shiller, Peter Bernstein, Nouriel Roubini and our local Aussie economist, Professor Steve Keen.

Our readers should, by now, appreciate the colossal magnitude of this financial crisis. When you listen the media, the phrase “since the Great Depression” is often mentioned. Make no mistake about this, this has the potential to be worse than the Great Depression (note: we are NOT predicting that it will happen).

The world’s stock market is rallying in the hope that the US government’s plan to nationalise the financial industry will be successful in stopping the core of the rot. New legislations has to be rushed through Congress by the end of next week to change the rules to make the plan legal. As in everything done in haste, we believe there will not be enough thought put into them to understand the long-term ramifications. It is probable that once the changes are in place, they will not be revisited again.

As we warned in Recipe for hyperinflation,

There is no way any politician can sell the message that America needs a severe recession (or even a depression) to cleanse the economy from the gross excesses, imbalances, blunders and mal-investments. Thus, it is very likely that they will have to fight deflation till the very bitter end, till the last drop of blood from their last soldier. Since the current structure of ?rules? will be too restrictive in such a war against deflation, there will be popular momentum towards the bending and rolling back of these ?rules.? If they press on relentlessly till the final end, there can only be one outcome: the US dollar will be joining the long list of failed fiat paper money in the annals of human civilisation.

Do property price always go up?

Monday, August 25th, 2008

One of the most entrenched superstitions is that property is a safe and secure asset class that always go up in price over time. It has come to a point that some people believe that property prices never come down. Some people will even cite the trend of the past 10 years to prove the point of this superstition.

But as Nassim Nicholas Taleb said in his book, The Black Swan: The Impact of the Highly Improbable, all you need to prove that not all swans are white is to find a black swan. In the same vein, all we need to prove this superstition false is to come up with examples of the opposite happening. The fact is, history is on our side- with the bursting of the Japanese bubble economy of the 1990s, property prices in Tokyo was said to have collapsed by 70% over the course of the decade. As of today, median house prices in the US has fallen around the order of 15% in one year.

For today’s article, we will draw out another big gun to blast away this superstition. At the beginning of the year, the ABC had a documentary about 350 years of Dutch experience- Dutch history pointing to real estate fall. In that documentary, it reported

The house sugar merchant Cornelis Sasbout built in 1617 at number 150 on Amsterdam’s Herengracht canal tells a cautionary tale about investing in property – prices fluctuate wildly, but are ultimately flat.

In that documentary, when it said “flat” prices, it means “flat” in real terms.

Mind you, the Herengracht is not some piece of forsaken real estate built in the middle of nowhere. It is a prime real estate for over 350 years, as this documentary reported:

Eichholtz says what makes his index stand out from house price histories in other cities is what he calls “constant quality” – the Herengracht has always been prime real estate. The index corrects for rising consumer prices but not wages.

What is the lesson here for Australia? Well, Australia is still sitting on an unprecedented debt bubble. For those who still need convincing, please take a look at Professor Steve Keen’s scary debt charts at Debtwatch No. 25: How much worse can ?It? get? and our commentary at Aussie household debt not as bad as it seems?. When the debt bubble burst eventually, we can be sure the frequently parroted justifications of this superstition (e.g. housing ‘shortage,’ immigration, etc.) will be revealed as hogwash. We would love to see those ‘experts’ who wrote reports that justify this superstition be paraded as clowns when they are proved wrong in due time (see Another faulty analysis: BIS Shrapnel on house prices).

Fox’s method of solving hen’s housing affordability

Tuesday, August 19th, 2008

Recently, we saw this article in the news media: First home buyer affordability still at 24-year low

“Affordability will only improve if all governments work together to remove the onerous tax burden and regulatory imposts on new residential construction.”

This quote was said by Housing Industry of Australia (HIA) chief economist Harley Dale. Is that a conflict of interest? This is the same problem that we mentioned before in News media contradiction regarding the Australian rental crisis?:

Rather, we believe that due to the way the human brain is wired, conflict of interests can often result in biased information, especially when the issue concerns money and wealth.

Asking the HIA for a solution to the housing affordability problem is the same as, in the words of one of our readers, asking “yet another fox to guard the hen house.” Basically, the HIA wants the housing affordability problem to be ‘solved’ by:

  1. Reduce government taxation burden on homebuilders so that there is a greater incentive to build homes.
  2. Release more land for housing construction.

What is the underlying assumption of this ‘solution?’ Well, this ‘solution’ assumes that there is a housing ‘shortage.’ But what if the assumption is wrong? In that case, this is what we said in Australian housing shortage myth,

When it comes to solving Australia’s housing problem, there is an entrenched superstition that makes many believe that there is a housing ‘shortage’ in Australia. This superstition has resulted in many proposed solutions to the housing affordability crisis that are completely useless, wasteful and counter-productive.

As we said, in that article,

In reality, the housing ‘shortage’ superstition is the result of an illusion. The illusion arises from the fact that there is a mismatch of housing demand and supply. In some parts of Sydney, there is an over-demand for housing, which gives rise to the housing ‘shortage’ illusion. In other parts of Sydney, there is an over-supply of housing (some of them brand new) that are unwanted.

Let’s imagine the government decides to remove all taxation burdens on builders and release all land for house building tomorrow. This will be a builders’ paradise. But will that be a home buyer’s paradise? If the government really do that, do you think the builders will begin a house building spree and solve the housing shortage and affordability problem? Well, consider one of our reader’s protests in Australian housing shortage myth:

Mis-investment, who wants to live on Paramatta Rd, especially where this building is, it’s on Parramatta Rd and miles from the city. Would you live there?

All the empty dwellings on the outskirts of the city are just mis-investment, they are overprice houses in areas where people don’t actually want to live or they can’t afford them anyway.

The context of this comment lies in the fact that there are a lot of brand-new apartments and houses in the outer suburbs of Sydney that remain unsold. They remained unsold because these brand new homes are undesirable for various reasons (e.g. too far from city, no transport infrastructure, etc.). Obviously, these builders are losing money because of insufficient demand for these homes. That could be a contributing reason for current recession in the home building industry.

Why are these homes undesirable in the first place? There are many reasons: lack of infrastructure development (especially transport), rising fuel costs that makes car ownership expensive, lack of amenities, far away from employment centres, etc. Worse still, look at the wasteful use of land in Sydney- lack of high-rise residential apartments even in places near the CBD. In Singapore, they have a population that is as big as Sydney squeezed in a land area several times smaller. It should be clear by now who had been sleeping behind the wheel to allow the situation to become what it is today.

Next, what are the many short-term solutions proposed by governments to tackle the home affordability crisis from the demand side? All the ‘solutions’ proposed so far involves boosting the ability of buyers to pay for the already exorbitant and overvalued prices of homes. Examples of such solutions include first homeowner’s grant, tax-reduced savings account and so on. These ‘solutions’ can be compared to solving hangover problems by supplying more alcohol for drinkers to drink their way out of pain.

So far, no government has the guts to propose a politically unpalatable way of alleviating this problem by encouraging further deflation of house price through a change in the tax regime. In fact, there are plenty of scope for further property price deflation. As Associate Professor Steve Keen said in Brace yourselves for recession, says Steve Keen,

I think something of the orders of 40 per cent of prices are simply financed by people’s expectations that the prices will keep on rising.

Well when this expectation goes, ultimately goodbye 40 per cent of the current price of houses.

The question is, which of these two would one want to be the trigger for property price deflation?

  • Changes in the tax regime

OR

  • Rising unemployment, rising mortgage rates, further unravelling of the credit crisis, economic slowdown

In Australia, we have a tax regime of fully taxing savings and half taxing speculation- interest income are fully taxed whereas there is capital tax exemption/concession for property ‘investment,’ negative gearing, etc. Such tax regime encourages people to speculate, fall deeper into debt and discourage savings, which is the last thing the Australian economy needs right now. If the government is unwilling even to alleviate the housing affordability crisis in the short term by changing the tax regimes, then Australia have to rely on an inevitable economic crisis to do that, which is more painful and a lose-lose outcome for everybody.