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posted on 07 February 2016

Steve Keen On Our Dysfunctional Monetary System

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The great tragedy of the global economic malaise is that it is caused by a shortage of something that is essentially costless to produce: money.

- - Steve Keen in Forbes

Steve Keen is one of the world's foremost students of the relationships between money, credit and economic growth, an area that has been ignored in much economic theory and analysis for many decades. The fact that he was prompted to criticize so fundamentally the very system he has studied is noteworthy.


Prof. Keen summarizes our current monetary problems, which he maintains are primarily the result of excessive private sector debt. He says this in the current Forbes article:

Both banks and governments can produce money at physically trivial costs. Banks create money by creating a loan, and the establishment costs of a loan are minuscule compared to the value of the money created by it - of the order of $3 for every $100 created.

Governments create money by running a deficit - by spending more on the public than they get back from the public in taxes. As inefficient as government might be, that process too costs a tiny amount, compared to the amount of money generated by the deficit itself.

But despite how easy the money creation process is, in the aftermath to the 2008 crisis, both banks and governments are doing a lousy job of producing the money the public needs, for two very different reasons.

The Private Sector Problem

The failure of the banks to produce the money needed by the economy now is because "they created too much of it in the past". Japan was the first major economy to experience this phenomenon. You might think that the rest of the world would learn from that but Steve provides the graphic proof that they simply followed suit:

Perhaps the rest of the world did not quite reached the extreme of the Japanese excess but Canada and China may yet get there. And what has been the experience of Japan? Prof. Keen:

... most of Japan's post-crisis credit growth occurred in the first half decade or so after its crisis. Take those early post-crisis years out, and the average rate of growth of credit in Japan has been minus 3 percent of GDP a year. Rather than adding to the money supply, banks have been reducing it for the last 20 years.

He suggests that shifting the Japanese credit growth experience forward in time to overlap with the Great Financial Crisis may provide insight to the future the rest of the world is facing today:

The Public Sector Problem

Prof. Keen says the problems here relate to "bad metaphors" and defective "ideology". The fantasy of an ideal world with "no-government, free market idyll" inspired by "conservative politicians from Reagan and Thatcher on" has curtailed government spending so that source of needed money has also been deficient. He cites the non sequiturs that "the government is 'like a household'" and should "live within its means".

He says that this thinking is okay for a barter-based economy. But that is not what runs the world today. (See the recent series on this subject by Derryl Hermanutz: Barter Thinking in a Money Economy - Part 1, Part 2, Part 3, Part 4 , Part 5, Part 6.)

Prof. Keen decries the ignorance of the public policy initiatives (which I would suggest are encouraged by the banks for deflection of attention from themselves). These initiatives have focused on the symptom of the monetary breakdown (rising public debt) instead of addressing the disease (excessive private debt). He writes:

Rather than effective remedies, we've had inane policies like QE, which purport to solve the crisis by inflating asset prices when inflated asset prices were one of the symptoms of the bubble that caused the crisis. We've seen Central Banks pump up private bank reserves in the belief that this will encourage more bank lending when (a) there's too much bank debt already and (b)banks physically can't lend out reserves.

Prof. Keen asks "How much longer can governments (and banks) continue with failed policies?"

He responds that if current policies of increasing bank reserves and implementing negative interest rates persist, the answer is "indefinitely". And, if we are all following the Japanese monetary footpath, quoting from Steve's closing paragraph, we will repeat what he sees happening to Japan:

The only direct impact of this policy [negative interest rates] will be to drive up asset prices yet again - and it might even lead to private banks increasing interest rates on loans to the private sector, as has happened in Switzerland. The net effect on the real economy will at best be trivial, and it will do naught to reduce Japan's private debt burden, which is the nub of its stagnationist problem.

Reforming the Monetary System

Prof. Keen does not mention details about the structure of the monetary system except to say early in the article that the cost of running a deficit (presumably he refers to interest) is trivial compared to the size of the deficit. I would like to point out that there is any interest at all is an arbitrary condition resulting from the decision of governments to relegate the actual creation of the money to private banks. There are solutions proposed for this system by many contributors to GEI and others, often discussing the U.S. but sometimes the EU and the UK. It has been a political decision in the U.S. to abrogate the specified responsibility in the U.S. Constitution (Article 1, Section 8): "To coin money, regulate the value thereof, and of foreign coin,".

Among the areas of discussion for monetary reform are the following:

Public Banking. The U.S. federal government could create part of its debt through a public bank. Money spent for infrastructure, public goods (education, health care, basic research, defense and safety, for examples) and other government expenditures as specified could be lent into existence by public bank credit and there would be no interest cost to the government. The benefit of using a public bank would be the added flexibility of debt security transactions with the private sector which could be varied as conditions in the economy changed. Prominent among those writing on this has been Ellen Brown, President Emeritus of the Public Banking Institute. Her recent articles are listed here.

Debt-free Money: This represents a radical departure from the existing system wherein the government simply issues money as needed for government expenditures and taxes only to remove excess money from the economy to suppress inflation. Some of those who have written on variations of this concept (in alphabetical order) are (click each name for lists of recent articles) :

See also: Adair Turner: A New Debt-Free Money Advocate (GEI News)

For recent arguments against debt-free money see posts by L. Randall Wray, Debt- Free Money And Banana Republics, Part One and Part Two.


Our Dysfunctional Monetary System (Steve Keen, Forbes 06 February 2016)

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