Exorcise the Debt Tumor

Excerpt from Sydney Morning Herald, 15 September 2009

'You have just come from your annual medical check-up, where your doctor assures you that you are in robust health.

Walking jauntily down the street, you bump into a practitioner of alternative medicine. He takes one look and declares: "You have a serious tumour. It must be removed or you will die."

You ignore him as you always have. One day later, a stabbing pain cripples you. You call your doctor, who initially refuses to send an ambulance because he knows you are well. Only when you lapse into a coma does he send one. Initially the doctor waits for you to revive spontaneously. But as your pulse starts to weaken, reluctantly he calls a retired doctor who has experience of a similar inexplicable malady in the distant past.

She prescribes massive doses of tranquillisers, painkillers, vitamins, and oxygen - all substances that had been removed from the medical panoply due to recent advances in medical theory.

After a year of expensive medical treatment, you return to health, and are released from intensive care. As you stride from the hospital, you bump into the practitioner of alternative medicine. "But they haven't removed the tumour," he declares.

One shouldn't have to spell out the details of such an analogy, but in times of widespread denial, it is necessary.

You are the economy; the tumour is a massive accumulation of private debt; your doctor is neoclassical economics; and the retired colleague is a so-called ''Keynesian'' economist (who doesn't know it - since her medical textbooks were poorly written - but she's actually following another economist called Paul Samuelson, not Keynes).

The alternative medicine practitioner follows Hyman Minsky's financial instability hypothesis (based on what Keynes actually did say - as well as the wisdom of Joseph Schumpeter and, in whispers, Karl Marx)...

According to Minsky's theory, capitalist economies can and do periodically experience financial crises (something believers in the dominant neoclassical approach to economics vehemently denied until reality - in the form of the global financial crisis - slapped them in the face last year).

These financial crises are caused by debt-financed speculation on asset prices, which leads to bubbles in asset prices. These bubbles must eventually burst, because they add nothing to the economy's productive capacity while simultaneously increasing the debt-servicing burden the economy faces.

When they burst, asset prices collapse but the debt remains. The attempts by both borrowers and lenders to reduce leverage reduces aggregate demand, causing a recession.

If the economy survives such a crisis, it can go through the same process again, with another boom driving debt up even higher, followed by yet another crash. But ultimately this process has to lead to a level of debt that is so great that another revival becomes impossible, since no one is willing to take on any more debt. Then a depression ensues.

That is where we were in 1987. The great tragedy of today is that naive neoclassical economists like Alan Greenspan and Ben Bernanke allowed this process to continue for another three or more cycles than would have occurred without their rescues.

Last year they did it again - only with methods they would have disparaged a mere year earlier (rational expectations macroeconomics, a modern neoclassical fad, preaches that government intervention cannot influence the level of economic activity at all - yet another belief that reality has recently crucified). This time, while the rescue has worked, the recovery they expect afterwards cannot happen - because there is almost no one left who will willingly take on any more debt.

This time, there is no re-leveraging way out. The tumour of debt has to be removed.'

Steve Keen is associate professor of economics at the University of Western Sydney