New York Times: Keen Right, Bernanke Wrong

22 Jul
Steve Keen, an Australian economist, used the ideas of another economist, Hyman Minsky, to  set forth the possibility of a global debt crisis that now seems prescient. In a 2000 book,  Mr. Bernanke briefly mentioned, and dismissed, Mr. Minsky. (Source: Demetrius Freeman/New York Times)

Steve Keen, an Australian economist, used the ideas of another economist, Hyman Minsky, to set forth the possibility of a global debt crisis that now seems prescient. In a 2000 book, Mr. Bernanke briefly mentioned, and dismissed, Mr. Minsky. (Source: Demetrius Freeman/New York Times)

Oh dear.

What does it tell you — particularly about the gross misallocation (and mis-remuneration) of human intellectual resources — when the New York Times declares the most powerful central banker on the planet, US Federal Reserve chairman Ben Bernanke, to be fundamentally wrong, and a humble Aussie economist, (now unemployed) Associate Professor Steve Keen, to be fundamentally right:

For a time, the period before the collapse was known as the “Great Moderation,” a term that Mr. Bernanke helped to publicize in a 2004 speech. Low levels of inflation, long periods of economic growth and low levels of employment volatility were viewed as unquestioned proof of success.

And what brought on that success? In 2004, Mr. Bernanke, then a Fed governor, conceded good luck might have helped, but his view was that “improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation.”

In 2005, three Fed economists, Karen E. Dynan, Douglas W. Elmendorf and Daniel E. Sichel, proposed an additional explanation for the Great Moderation: the success of financial innovation.

“Improved assessment and pricing of risk, expanded lending to households without strong collateral, more widespread securitization of loans, and the development of markets for riskier corporate debt have enhanced the ability of households and businesses to borrow funds,” they wrote. “Greater use of credit could foster a reduction in economic volatility by lessening the sensitivity of household and business spending to downturns in income and cash flow.”

At least Mr. Bernanke’s hubris was not as great as that of Robert E. Lucas Jr., the Nobel Prize-winning University of Chicago economist. In 2003, he began his presidential address to the American Economic Association by proclaiming that macroeconomics “has succeeded: Its central problem of depression prevention has been solved.”

In his speech last week, Mr. Bernanke cited several assessments of the Great Moderation, including the one by the Fed economists. None questioned that it was wonderful.

The Fed chairman conceded that “one cannot look back at the Great Moderation today without asking whether the sustained economic stability of the period somehow promoted the excessive risk-taking that followed. The idea that this long period of calm lulled investors, financial firms and financial regulators into paying insufficient attention to building risks must have some truth in it.”

One economist who would have expected that development was Hyman Minsky. In 1995, the year before Minsky died, Steve Keen, an Australian economist, used his ideas to set forth a possibility that now seems prescient. It was published in The Journal of Post Keynesian Economics.

He suggested that lending standards would be gradually reduced, and asset prices would rise, as confidence grew that “the future is assured, and therefore that most investments will succeed.” Eventually, the income-earning ability of an asset would seem less important than the expected capital gains. Buyers would pay high prices and finance their purchases with ever-rising amounts of debt.

When something went wrong, an immediate need for liquidity would cause financiers to try to sell assets immediately. “The asset market becomes flooded,” Mr. Keen wrote, “and the euphoria becomes a panic, the boom becomes a slump.” Minsky argued that could end without disaster, if inflation bailed everyone out. But if it happened in a period of low inflation, it could feed upon itself and lead to depression.

“The chaotic dynamics explored in this paper,” Mr. Keen concluded, “should warn us against accepting a period of relative tranquillity in a capitalist economy as anything other than a lull before the storm.”

When I talked to Mr. Keen this week, he called my attention to the fact that Mr. Bernanke, in his 2000 book “Essays on the Great Depression,” briefly mentioned, and dismissed, both Minsky and Charles Kindleberger, author of the classic “Manias, Panics and Crashes.”

They had, Mr. Bernanke wrote, “argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior.” In a footnote, he added, “I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go.”

It seems to me that he had both Minsky and Kindleberger wrong. Their insight was that behavior that seems perfectly rational at the time can turn out to be destructive.

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3 Responses to “New York Times: Keen Right, Bernanke Wrong”

  1. mick July 22, 2013 at 8:17 pm #

    Steve Keen put his money where his mouth was and sold his house. I respect somebody who puts it all on the line like Keen did. Although property values are roaring back this game is still well in play.

    I tend to agree with Keen as it looks like the money printing stampede is intended for no other reason other than to alleviate the US, Europe and Japan of their debt repayments by devaluing their respective currencies. By doing so these countries also improve their export industries as they become more competitive. The long term effect appears to be that inflation is going to take off which in turn will drive the gold price up. Those with money invested in banks will be the losers as asset prices continue to escalate and inflation roars on.

    The pertinent question is: how will it all end? I have read that helicopter Ben is caught between the devil and the deep blue sea. On the one hand he knows that he needs to end the money printing quicksand he is in. On the other hand the markets may fold if the funny money ends as it has become addicted to the manna from heaven. If inflation takes off like a rocket then how do the money printing economies deal with a shift to gold and silver?

    One thing is for sure and that is that the time frame and the extremity of what we are all in and the severity of what is ahead is unknown and depends on what the main players do to fix or prolong the current madness. A good time to go live on an island without internet or TV.

    • Chris July 26, 2013 at 12:32 pm #

      The gold ‘price’ won’t go up at all. The price of gold has nothing to do with the value of gold.

      Digest that for a second.

      99% of all gold transaction large enough to affect price are transactions involving futures contracts or other paper derivatives. When the price of gold is pegged to the value of a contract for the future delivery of gold, then the ‘price’ relates to a few things nothing to do with demand or supply. Firstly, the stock of paper contracts in existence lowers the price via dilution. If more ‘gold’ contracts are issued in to the market, then the price is lowered. The other critical factor is the counterpart risk associated with the contract to ‘possibly’ deliver as required. All of these contracts have cash settlement as an option, in effect making the contract as useful as a contract to give you your cash back later. Those two forces both force the price down, that being excess claims on future production and the risk that the contract will never deliver anything but the currency you bought the contract with. The opposite force to this is ‘investors’ wanting to ‘gain exposure’ to price that ‘should’ go up as inflation increases through currency debasement. Well, sad to say it to ‘win’ via price by buying gold you would have to assume more people will value paper contracts tomorrow than do so today.

      The gold story is complicated, far more so than I have even explained above and certainly one day gold owners will be ‘rich’, but that day will only occur if the price of physical gold is no longer pegged to the price of a contract promising to ‘maybe, but probably not’ deliver gold. In effect, the only way for gold to become truly valuable is for the counterpart failure to occur, and for the price to massively decline as a result.

      • mick July 26, 2013 at 5:56 pm #

        Fair comment but I think that you are missing the point.

        Both the silver and gold prices have been manipulated. Silver has been held down for several decades whilst the coffers have been all but empty and now the same is happening to gold.

        Where we will have to disagree is clearer when we look at the bigger picture. We have paper contracts and we have the physical gold. It matters not what the paper value assigned by the rigged system is if the physical product is being snapped up until it is gone. It is. I have heard the stories about queues in the third world waiting to trade their fiat currency for real gold. And then of course China is not stockpiling for the fun of it either as are the central banks in many countries who are apparently also buying the real stuff.

        So what is the end game? And why are central bankers and their governments adopting bail in provisions? It feels like there is some bad stuff coming but then none of us will know until the fat lady sings. Those in charge will make sure of that, just like a bell is not rung at the top of a stock market bull run. We not find out that we have been rorted by those we elect to look after our interests until the game is over. After that it will be governments unappologetically justifying their positions and behaviours. Ain’t like so wonderful…..

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