Steve Keen's July Debtwatch (excerpts)

[D.Turtle]

In the last six months, the phrase “Green Shoots of Recovery” has entered the economic lexicon. It appeared to some observers that the global recession was coming to an end, while Australia itself was likely to barely feel its impact.

I would be as pleased as anyone if these “green shoots” were true harbingers of a genuine end to the economic downturn–not because I would enjoy being wrong for the sake of it, but because my expectations for the future are so bad that I’d prefer to see them not come to pass.

Unfortunately, on current data I expect that “green” is a better description of the knowledge level of those making the optimistic predictions, than of the colour of any budding economic recovery.

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Of course, disputes between academic economists don’t matter in the real world, and most newspapers report the announcements of bodies like the OECD as statements of wisdom about the future–until, that is, a crisis like the Global Financial Crisis makes a mockery of the OECD’s neoclassical fantasies.

And what a mockery. This was the OECD’s forecast for the world economy in June 2007:

EDITORIAL: ACHIEVING FURTHER REBALANCING

“In its Economic Outlook last Autumn, the OECD took the view that the US slowdown was not heralding a period of worldwide economic weakness, unlike, for instance, in 2001. Rather, a “ smooth” rebalancing was to be expected, with Europe taking over the baton from the United States in driving OECD growth.”

“Recent developments have broadly confirmed this prognosis. Indeed, the current economic situation is in many ways better than what we have experienced in years. Against that background, we have stuck to the rebalancing scenario. Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.” (OECD Economic Outlook, Volume 2007/1, No. 81, June 2007, p. 7)

Yeah, right. Instead the global economy was already well into the greatest economic crisis of the last 60 years. The next two years tore the OECD’s 2007 forecasts to shreds.

One might hope for some soul searching as a result of this–and hopefully some is occurring behind closed doors. But in a clear sign that the OECD hopes to see “Business as usual” restored in its modelling approach as well as the actual economy, its current Economic Outlook discusses the process of recovery from an economic crisis that it completely failed to foresee:

EDITORIAL: NEARING THE BOTTOM?

“OECD activity now looks to be approaching its nadir, following the deepest decline in post-war history. The ensuing recovery is likely to be both weak and fragile for some time. And the negative economic and social consequences of the crisis will be long-lasting. Yet, it could have been worse. Thanks to a strong economic policy effort an even darker scenario seems to have been avoided. But this is no reason for complacency; the need for determined policy action remains across a wide field of policies…”

“In summary, it looks as if the worst scenario has been avoided and that OECD economies are now nearing the bottom. Even if the subsequent recovery may be slow such an outcome is a major achievement of economic policy. But this is no time to relax — ensuring that the recovery stays on track and leads towards a long-term sustainable growth path will call for major policy efforts going forward.” (OECD Economic Outlook, Volume 2007/1, No. 81, June 2009, pp. 5 & 7)

With its utter failure to see this crisis coming, why does anyone still take the OECD seriously? Probably for the same reason that people still generally obeyed the Captain of the Titanic after it had struck the iceberg: authority counts for a lot in a crisis, even if the person in authority actually caused it.

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I found out about Professor Steve Keen from J or Aerius linking to a Debtwatch report some time ago and have found him quite convincing in his arguments about the economy, how it works (and why neo-classical economics doesn't), and why we are in a depression.

Basically, it comes down to the following: Total (aggregate) demand in an economy is made out of GDP + the change in debt. In the last several decades, debt has grown in massive amounts, making the change in debt the driving factor in the economy (in the US and most of the world). The massive growth in debt fueled the economic growth of the last decades, but has now reached a level that is unsustainable. This is now forcing people (and companies) to start paying down the debt. The problem is that this causes a massive fall in demand. While the governments of various countries (especially the US) are trying to step into this gap, it is simply too big. And even if this drop in demand could somehow be alleviated by somebody else stepping in and taking on massive amounts of debt, this would only restart the cycle and make the resulting crash even bigger.

Now, my explanation is obviously incomplete and inadequate, but I hope it gets the general idea across.

Here are some of the graphs in his current Debtwatch Report that show this relationship between debt and the economy:

Private debt has gone from adding 20-30% to US GDP, to now SUBTRACTING 10-15% from US GDP. The US government is trying to counteract this with massive spending, but it is dwarfed by the deleveraging in public debt, leading to the result in the next graph:

And to make it entirely clear what impact this deleveraging has on the economy, there is the following graph:

Oh, and for those pointing at the stock market, I leave you with the last graph:


I highly recommend reading the entire report at his blog.