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"We are in the Greatest Financial Bubble of all Time"
by Steve Keen and Fredmund Malik
Thursday Feb 4th, 2010 5:03 AM
"An old world perishes as a new world arises-pictorially comparable to a caterpillar that dies because the butterfly comes to life. What is called financial crisis is only a superficial symptom.. One of the main causes of the debacle is the totally misguided Americanized corporate governance with its disastrous shareholder value doctrine that still dominates.. Einstein knew problems cannot be solved with the same methods that caused them.." (Fredmund Malik)

Interview with Steve Keen

[This interview with Steve Keen, professor at the University of Western Sydney, published in: Frankfurter Allgemeiner Zeitung January 7, 2010 is translated from the German on the Internet,]

Contrary to optimistic predictions, the economic- and financial crisis is not over, insists Professor Steve Keen at the University of Western Sydney. He had warned of this crisis. To avoid repetition of the financial crisis, dogmatic economists and the financial sector must be brought down, he says. He expects a striking deflationary development since the money multiplier does not work.

Prices on the stock market are rising. Many strategists declare the crisis is over and growth will begin again. Do you believe this?

No. I think the irrational exuberance dominant before the crisis will return. I compare the development with the years 1929 and 1930. At that time the prices on the stock markets soared dramatically in November. Many thought the year 1930 would be a good economic year. That did not happen; the rally in prices ran out.

What were the causes of the crisis and why is it not over?

The basic problem is that excessive debts were amassed in a speculative mania. Investors bought (property) assets in the expectation of selling them later at higher prices and grasped more and more foreign capital in this process. This mechanism was central for the American economy. Money was earned by speculation, not by producing goods. Rising asset prices were driven by ever higher discrepancies between debts and revenues. Such processes run until they break. We have now arrived at that point, I think. The private sector must reduce its indebtedness. This will shrivel the aggregate economic demand.

The crisis seems to have interrupted this process – but only to start all over again.

That is true in a certain sense. The economy now grows on the basis of public spending programs. My thesis is that the traditional economic theory is jointly responsible for the crisis and contributes to its being more serious than it had to be. Traditional economic theory ignored the absolute indebtedness and started from the rational behavior of borrowers. If Alan Greenspan had not reacted in a “rescuing” way in the stock market crash in 1987, we would have had a corrective mini-depression that would have been easier to conquer. Since the government and central banks make fresh demands for another 20 years of exorbitant consumption on credit, the relation between debts and revenues went their separate ways and the economic repercussions were correspondingly great.

Were we not rational?

Economic policy was defined by neo-classical economists like Robert Lucas and Thomas Sargent who argued for the theory of rational expectations. Governments cannot positively influence economic development. Governments did not expect a crisis in the private sector that we now witness. Robert Prescott who was awarded the 2004 Nobel Prize for economics even declared the capitalist system is stable and disturbances only start from the public sector. Then a rethinking occurred. Public spending programs amounting to four to six percent of the world social product prevented our falling deeper in crisis. This showed the neoclassical theory is wrong.

Can state spending compensate for the debt reduction of private households?

As soon as the stimulation measures run out, the indebtedness process will lead to a shriveling economy, above all in states like the United States marked by a high relation of debts to gross domestic product. Even if the state stimulation strategies are extended or renewed, they will hardly be enough to compensate for the depressive effect. A development similar to Japan is marked out. In Japan, the growth of the past years was not enough to cushion the population growth. So unemployment increased.

How could this have been avoided?

Indebtedness must be tackled in its core. Asset-price spirals were financed in countries like the United States, Great Britain and Australia. Responsibility lies more on the creditor side than on the debtor side. In 1990, the relation of mortgages to gross domestic product in Australia was 17 percent. Today it amounts to more than 80 percent. Banks do a good business in financing professional speculators – I do not say investors. When these suffered setbacks in the 1990s, the banks financed private persons and bet on rising home prices. We do not need the financial sector for this. The financial sector should be focused only on serving industrial firms and new firms, instead of promoting Ponzi-systems.

Will this happen?

No. Many of the bailout measures in America are oriented at bailing out the existing financial system. This has failed for a long time on account of irresponsible and bad awarding of credits. The best solution would be removing the existing debts in one way or another. One possibility would be simply writing them off. This would lead to the bankruptcy of most banks, which could then be nationalized and later re-privatized. Another possibility would be debt cancellation through an inflationary process. However these variants are ignored. In Australia, consumers are encouraged again to become more heavily indebted. New debts would lead to more growth, which would be good according to this logic. Viewed in the long term, this would allow false securities to grow faster than the real economy and we would have to accept this.

What would you do if you could join the conversation as a politician?

Thanks be to God, I am not a politician. My cure would hardly be put into action. In the last years, the American and British economies became strongly dependent on the insurance-, finance- and real estate businesses. However large parts of production were outsourced to China. If this process were reversed, around 20 percent of the American population would be immediately unemployed. Now they not only make nothing useful but much of what they do is counter-productive. The transitional process would be very hard. In the sense of Machiavelli, one can be glad in the short-term that the radical measures have not been carried out. Nevertheless it will take years before it becomes clear that the prescriptions now applied will not work. Then the problems and imbalances which arose in the past 20 years can be first tackled.

What will happen to the banks?

The banks will perish. Without the state bailout actions, most mammoth American banks would not have survived. Even Goldman Sachs would have gone under. However the support measures are leading them to act as in the past – although this led directly into crisis. Around 80 percent of the TARP-funds intended to revive the economy went directly into speculation on the stock market. Only for that reason did stock prices rise so dramatically. The banks are returning to “business as usual” even though the pseudo-growth before the crisis was triggered by the increased proportion of debts to the gross national product. This cannot be continued endlessly.

What does that mean?

When we look back in the future, we will see we were in the greatest financial bubble of all time. One reason for that bubble was the bank sector that went completely out of control. The second reason lies in the neoclassical economic theory that theoretically underlay and justified the development. To avoid repetition, dogmatic economists and the financial sector should be bled white. Instead they are encouraged to the same conduct that brought us directly into crisis.

Do you see someone who could bring about this change?

Not at the moment. However Barack Obama could ultimately be forced to this. After his first year in office, many voters are disappointed. He promised change that has not occurred. In the coming years, he may do an about-face and throw out Summers, Geithner and other advisors of the neoclassical school. Otherwise he will perish like Hoover during the Great Depression.

Many states are spending enormous sums that they do not have. Can they afford this?

We live in a world with a mixed credit- and fiat-monetary system. Banks can create credits practically out of nothing and governments can issue I-O-Us and finance them out of nothing. A country like the United States can create as many dollars as it wants with its own central bank (Federal Reserve) – without any limits (apart from foreign trade). For this reason, dollar-devaluation is conceivable.

What does that mean?

In the past 40 years, above all during the past 20 years, the financial system created credits out of nothing and financed speculations, not anything substantial. We have not increased productive capacities. To recalibrate the system, we must get away from the credit-creation of banks and return to the so-called fiat-money of the central bank. What happened financially in the past 20 years was not economically healthy. The seeming prosperity gained in this time was an illusion in a certain sense. The living standard must actually fall in the framework of a necessary normalization. However we are still far from accepting this. This is especially true for the political class.

What does this mean for investors?

One should first look back to the 1920s and prudent investing at that time. Then it was best to bid farewell to stocks and “go into cash.” Whoever invested in securities and raw materials had to accept losses later. I am not a “gold bug” since price development is too volatile. But gold offers certain attraction when paper currencies lose value since financial assets are much too highly valued.

Are you a deflationist, someone who believes in a chronic dramatic drop in prices?

Yes, I am a deflationist first for historical reasons. In the 1930s, we had a deflationary development of ten percent over two years at the beginning of the great economic depression. Second, I doubt the arguments of the Austrian school that derives an inflationary development from the massive amount of money. I fear they do not rightly understand the money-creation process and the development of inflationary impulses. They underrate the enormous quantity of money that must be created to lead to inflation.

Why is that?

In the United States, the debts of the private sector amount to $42 trillion. The Federal Reserve must bring at least $25 trillion directly in circulation. Instead it only printed one trillion in the expectation that the money-multiplier would increase the amount ten-fold. This assumes the American private sector would accept nine trillion dollars of new debts. But that is unrealistic. At the moment, no credits are awarded and no credits are accepted. Thus the mechanism cannot function.

What is the origin of deflation?

Deflation follows from the classical mechanism of a debt crisis. Firstly, unemployment is high and employees must put up with wage cuts. Secondly, businesses want to keep their market shares amid falling demand by lowering prices. This leads to a deflationary spiral irrespective of what happens on the monetary plane.

What do you say about Bernanke’s famous helicopter?

Empirically the assumed money-multiplier does not function. An enormous fleet of helicopters would be needed to drop a very massive quantity of money. I do not believe Americans will do this. Conventional economic theories only explain very badly how capitalism functions. If one follows their theses, deep crises occur. If one tries to solve the crises with them, no way out is found. I fear Bernanke will pursue the wrong policy until he loses his office.

What do you expect for the next years?

I think it will slowly become clear that the crisis is not over. Growth weaknesses and high unemployment will be countered again and again with new stimulation measures instead of tackling the debt problem and rehabilitating the banks. The growth will be inadequate and unemployment will increase in America and Great Britain. The discovery that the established economists are the real problem will finally be accepted.

Will politics then change its methods?

Yes – and it will change its advisors. In his 1933 inauguration speech four years after the beginning of the Great Depression, Franklin D. Roosevelt declared: “The creditors define religion and propose more debts as the only method for solving the debt crisis.” That is a good picture and can be transferred to the present time.


By Fredmund Malik

[This interview published in: Frankfurter Allgemeiner Zeitung, January 8, 2010 is translated from the German on the Internet,]

[The current economic- and financial crisis cannot be solved with past conventional methods, explains Professor Fredmund Malik at the University of St.Galen, Switzerland. The crisis is only a superficial symptom for the greatest system transformation of history – from a money- to a knowledge-society in the opinion of the university instructor, business advisor and author.]

To really overcome the crisis, new regulation systems are needed that take account of complexity and are not oriented in the short-term interests of pseudo-investors. We must also learn that the world is not ruled by money as many argue but far more by elementary humanliness, he explains.

The economic- and financial crises are talked about everywhere. How would you describe the present situation?

An old world perishes as a new world arises. This is pictorially similar to a caterpillar dying because the butterfly comes to life. What is called financial crisis is only a superficial symptom. The economy and society are going through the greatest worldwide transformation in history to a society whose most important feature is its extreme complexity. Therefore I call it the complexity society.

The capital of the complexity society is knowledge, not money. Information is in control here, not power. Conventional organizations do not function under complexity conditions since their origin reaches deep into the last century when completely different conditions prevailed. No wonder lack of orientation and helplessness rule today and lead to helplessness and often blind actionism. Most only see the old in the new. Familiar reflexes are suddenly radically wrong – like car drivers who must drive left instead of right overnight.

How could this happen?

Globalization accelerates the process of exponential complexification. The new realities are hyper-complex, ultra-dynamic and linked system configurations. Conventional methods and ways of thinking are completely unsuited for understanding and managing such systems. These systems cannot be calculated, as the collapse of risk management in the banks proves.

With the long outdated theories and methods of today’s economy, the disaster could not be seen coming. The systemic-cybernetic instruments that I developed in my organization discovered the crisis-tsunami early on and predicted its course. My co-workers use these instruments for our clients. Our clients have not lost any money.

Symptoms for the developing storm were the increased number of false business strategies like the Daimler-Chrysler merger about which I warned executives at that time. Most bank strategies were wrong since they ignored the true complexity of the stock market. Traditional consulting bears an immense responsibility here.

One of the main causes of the debacle is the totally misguided Americanized corporate governance with its disastrous shareholder-value doctrine that still dominates. This must be radically and completely eliminated since this programmed the systemic and unavoidable colonization and derangement of large parts of the economy.

The market/capitalism is culpable, it is often said. Is this true or did it not simply develop its forces symmetrically on account of false incentive structures, lacking transparency et cetera?

Markets need dynamic cybernetic regulation systems so their self-organization can function. Instead grotesque neoliberal malformations arose. Cancer-like influences destroying the system penetrated the markets for 15 years, like purely pecuniary money-driven ways of thinking. With inner inevitability, this must lead to collapse. This is a well-known and well-researched law in complex systems that is ignored with impunity.

What role do monetary and fiscal factors play in this connection?

The debacle was caused and intensified by these factors. Therefore measures of this kind are not solutions for the crisis. Einstein knew problems cannot be solved with the same methods that caused them. Past measures were largely based on a grotesque one-dimensional idea of people reduced to the pure economy. Seldom before have economic theories showed their unreliability more clearly. Most humans are not rational-economic beings in the sense of the economy. The social sciences have long demonstrated this. People do not submit or resign to the unrealistic economic profit-maximization calculations. Money-driven egocentric persons incapable of coordination exist but this is a pathological manifestation or pheno-type inflicting irreversible damage at the top of businesses.

How can we extricate ourselves from the mess?

Pictorially expressed, the nervous system has broken down, not the (blood) circulation. Fed chairman Ben Bernanke had an early trace of understanding when he said in September 2009: “We have a total loss of control.” New regulation systems are necessary that do justice to the complexity and are not oriented in the short-term interests of pseudo-investors.

The world is ruled by elementary humanliness far more than by money. In today’s societies, enormous potentials lie fallow. Intelligence, creativity and information are unused to an unimaginable extent. As I observed in my daily contacts with many leaders for years, resignation, de-motivation, agony and bitterness spread, especially where shareholder value and money-obsession prevail. A policy that knows how to mobilize these fallow potentials can win elections and find solutions. These mobilizing ideas exist. We have tested them for years and apply them daily.

Politics must understand that today’s problems are complex and no longer left or right. Solutions are right or wrong, not red, blue or green. Solutions can hardly arise out of contemporary party structures that have their roots in the early 20th century.

Can the state play a crucial role without provoking the next dislocations?

Time could be saved with past measures. However a very fast and highly effective implementation of measures is necessary. This is lacking on a broad front. Shaping public opinion and will is slow, clumsy and dominated by pressure groups. Decision-making processes take too long. The results are watered-down compromises, the smallest common denominator instead of the largest number. The necessary systems and infrastructures are not implemented.

Implementing requires reliably functioning organizations in all areas. This means true and not false management and the effort of high-powered cybernetic systems that have long been conventional in technology but are less known in the world of organizations. For example, a new beginning would occur if auto companies applied the same functional principles to themselves that they use in their intelligent automobiles.

What must change to avoid further crises?

One of the keys is a brute change of the past disastrous corporate governance. Another is a radical reform of the training and retraining of today’s future leaders. The misguided way of shareholder-oriented business leadership comes from universities, countless MBA-programs and the world of consulting. Some media have actively cooperated. Whoever spreads disastrous false management doctrines prevents solutions and intensifies the crisis. If nothing changes, the consequence will be a social catastrophe.

How should past executed and planned measures be judged?

Liquor is given the alcoholic so the trembling stops.

How can businesses act most skillfully in this environment?

The answer is different according to the business type. The type that I call entrepreneurial-led businesses has the best chance of surviving. In this type repressed in MBA-courses, the business itself, its productive power and functional efficiency are at the center, not the predatory greed of interest-groups like shareholders or stakeholders. This business must also introduce new methods so its future is not lost under the changed conditions of high complexity, linkage and dynamism.

Fundamental innovations are necessary in the big corporations listed on the stock exchange. Conventional consulting drives them into ruin if leaders outfitted with the right knowledge do not responsibly shift the lever. The unions could have a decisive role here by helping reset the points from false to true corporate governance so the functioning of the business itself is central, not financial markets and so-called free-floating investors who reshuffle their stocks every few weeks and have no real interest in the business. Such measures will immediately spread because strategy and culture will be radically reoriented.

How do you position yourself as an experienced and skilful investor and where will you be engaged?

For years, the best investment has been cash. The prescription was: forget profit and preserve substance. Return of investment was and is the success principle, not return on investment. This investment policy needs a currency reform since one can only muddle on in the old paths. In the continuing deflation, cash will be worth more daily since all prices will fall with less revenue, especially tangible costs like stocks, raw materials and precious metals. To understand this is extremely hard for many because they lack the necessary knowledge and only the old seems to exist in the new. A Copernican change is due.

“The End of Illusion and the Beginning of the Future”
“The Cure is the Sickness” by Jorg Goldberg
“Democracy is a Useful Fiction” by Chris Hedges
“The Quiet Coup” by Simon Johnson
“Ways Out of the Crisis” by Jean-Paul Fitoussi and Joseph Stiglitz

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