The Fiscal Cliff—Lessons from the 1930s
Steve Keen
www.debtdeflation.com/blogs
www.debunkingeconomics.com
Key insights
• Understanding banks, debt & money key to understanding crisis
• Economists didn’t see the crisis coming because they ignore banks:
– “I’m all for including the banking sector in stories where it’s
relevant; but why is it so crucial to a story about debt and leverage?”
(Paul Krugman, “Minsky & Methodology”)
• Banks crucial because lending increases cash flow in the economy
– Effective demand is income plus the change in debt
– Analysis of dynamics of debt
• Explains the crisis
• Gives guidance to what the future may hold…
Key data: Debt to GDP ratios since 1920
• Why now is comparable to The Great Depression
Long Term Debt to GDP
320
293.3
P rivat e
P ublic
266.7
Percent of GDP
240
213.3
186.7
160
133.3
106.7
80
53.3
26.7
0
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
2020
The economic crisis
• A fall in GDP, but nothing like the Great Depression…
Nominal and Inflation-adjusted GDP
7
1.610
Begin
7
1.510
7
US $ million
1.410
7
1.310
7
1.210
7
1.110
7
110
Nom inal GDP
Inflat ion-adjust ed GDP (2005 dollars)
6
910
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: BEA
GDP and the levels of private & public debt
• Private debt far bigger than both GDP and public debt…
USA Debt Levels and Nominal GDP
7
4.510
7
410
7
3.510
P rivat e Debt
Governm ent Debt
GDP
Begin
US $ million
7
310
7
2.510
7
210
7
1.510
7
110
6
510
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
US Flow of Funds T able L 1
GDP and the change in private & public debt
• Crisis began when growth of private debt stopped…
Annual Change in Debt and Nominal GDP
US $ million
7
1.910
Begin
7
1.810
P
rivat
e
Change
7
1.710
Governm ent Chan ge
7
1.610
7
GDP
1.510
7
1.410
7
1.310
7
1.210
7
1.110
7
110
6
910
6
810
6
710
6
610
6
510
6
410
6
310
6
210
6
110
0
0
6
 110
6
 210
6
 310
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
2 years of heavy private
sector deleveraging
US Flow of Funds T able L 1
Effective demand as GDP plus change in debt
• Now the scale of the crisis is obvious…
Aggregat e demand 2000 till Now
7
210
7
1.910
7
1.810
Begin
GDP
+ Privat e Change
+ Governm ent Ch ange
7
1.710
US $ million
7
1.610
7
1.510
7
1.410
7
1.310
7
1.210
7
1.110
7
110
6
910
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
US Flow of Funds T able L 1
Change in debt and unemployment
• Rising private debt causes falling unemployment;
• Rising unemployment causes rising public debt
Unemploy ment & Change in Debt
Begin
40
11
35
10
30
9
25
8
20
7
15
6
10
5
5
4 0
0
3
2
1
Unemploym ent
P rivat e Debt
Governm ent Debt
5
 10
 15
0
 20
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Annual change in debt as percent of GDP
Unemployment rate percent
12
Debt and asset prices
• Accelerating debt causes rising asset prices
10
200
8
190
6
180
4
170
2
160
0
0 150
2
140
4
130
6
120
8
Mort gage Debt Change
Real House Price Index
110
 10
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Case-Shiller Real House Price Index (1890=100)
Percent of GDP p.a.
House Prices & Change in M ortgage Debt
The 1930s collapse in GDP
• Much sharper falls in nominal and real GDP…
Nominal and Inflation-adjusted GDP
6
End
6
110
100000
Nominal GDP $ million
1.110
90000
900000
80000
800000
70000
700000
60000
600000
Nom inal GDP
Inflat ion-adjust ed
50000
500000
1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940
US Flow of Funds T able L 1
Inflation-adjusted (2005 dollars)
110000
GDP and debt levels
• Much smaller debt bubble in the 1930s than today…
US $ million
USA Debt Levels and Nominal GDP
180000
170000
P rivat e Debt
160000
Governm ent Debt
150000
GDP
140000
130000
120000
110000
100000
90000
80000
70000
60000
50000
40000
30000
20000
10000
0
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
US Census
GDP and change in debt
• Much longer period of private sector deleveraging
• Much slower and smaller government deficit response
Annual Change in Debt and Nominal GDP
130000
P rivat e Change
Governm ent Change
GDP
120000
110000
100000
90000
US $ million
80000
70000
60000
50000
4 years of heavy private
sector deleveraging
2 more years
40000
30000
20000
10000
0
0
 10000
 20000
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
US Census
Effective demand: much longer plunge below income
• Extended deleveraging compared to today
• Relatively minor government stimulus response
Aggregate Demand 1925 till 1939
120000
GDP
+ Privat e Change
+ Governm ent Change
110000
US $ million
100000
90000
80000
70000
60000
50000
40000
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
US Census
The Fiscal Cliff of 1937
• Dip back into Depression as private sector deleveraging recommenced
Unemploy ment & Change in Debt
Unemployment rate percent
27.5
25
40
Unemploym ent
P rivat e Debt
Governm ent Debt
35
30
22.5
25
20
20
17.5
15
15
10
12.5
5
10 0
0
7.5
5
5
 10
2.5
 15
0
 20
1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
Annual change in debt as percent of GDP
30
Recovery in WWII
• Huge increase in government stimulus drives GDP up
• Private sector delevers during WWII with minor impact on GDP
USA Debt Levels and Nominal GDP
300000
270000
240000
P rivat e Debt
Governm ent Debt
GDP
US $ million
210000
180000
150000
120000
90000
60000
30000
0
1925
1927
1929
1931
1933
1935
1937
US Census
1939
1941
1943
1945
Private sector deleveraging during WWII
• Fall in private sector debt far greater during WWII than during Great
Depression, but little impact on GDP
• Stimulus, not austerity, ended Great Depression
Annual Change in Debt and Nominal GDP
230000
210000
190000
P rivat e Ch ange
Governm ent Change
GDP
170000
US $ million
150000
130000
110000
90000
70000
50000
30000
10000
0
 10000
 30000
 50000
1925
1927
1929
1931
1933
1935
1937
US Census
1939
1941
1943
1945
Private sector finishes deleveraging during WWII
• Private debt 45% of GDP in 1945—down from 175% in 1930
Annual Change in Debt and Nominal GDP
280000
260000
240000
GDP
+ Privat e Change
+ Governm ent Ch ange
220000
US $ million
200000
180000
160000
140000
120000
100000
80000
60000
40000
1925
1927
1929
1931
1933
1935
1937
US Census
1939
1941
1943
1945
Takeaway Points
• Private debt and government debt are independent
– But they affect each other
• Both boost demand in the economy when they rise
– and reduce it when they fall.
• Private debt is more important than public debt because
– it is so much larger, and
– it drives the economy whereas government debt reacts to it
• The crisis was caused by the growth of private debt collapsing
• Government debt rose because the economy collapsed
– and it reduced the severity of the crisis
• A premature attempt to reduce government debt through “The Fiscal
Cliff” could trigger a renewed bout of deleveraging by the private
sector, which could push the economy back into a recession.
• Main challenge of public policy is not reducing government debt
– But managing the impact of the “Rock of Damocles” of private debt
that hangs over the economy.