Apr 092018

Keith Haring Retrospect 1989


Longtime and dear friend of the Automatic Earth, professor Steve Keen, wrote an article recently that everyone should read (that goes for everything Steve writes). It’s hard to select highlights, but I’ll give it a try. Steve explains where our housing markets went off the rails, what (short-sighted) interests politicians have in subverting them, and, something rarely addressed, why housing markets are unlike any other markets (the turnover of existing properties is financed with newly created money)

He then suggests some measures that might counter this subversion, with a twang of It’s a Wonderful Life nostalgia thrown in. That nostalgia, which will be seen by many as outdated and a grave mistake in these ‘modern times’, instead makes a lot of sense. We might even say it’s the only way to get back on our feet. It resides in the idea that money-circulating building societies, rather than money-creating banks should be in charge of the housing market.

Because it’s not supply and demand that rule the market today, it’s available debt (credit). And banks can, and will, always create more debt at the stroke of a keyboard. That is, until they can’t, and then house prices must and will of necessity fall off a cliff. In Steve’s words: “..mortgage credit causes house prices to rise, leading to yet more credit being taken on until, as in 2008, the process breaks down. And it has to break down, because the only way to sustain it is for debt to continue rising faster than income.

Still, it left me with a big question. But I’ll ask that at the end; here’s Steve first.


The Housing Crisis – There’s Nothing We Can Do… Or Is There?

[..] the UK data is remarkable, even in the context of a worldwide trend to higher levels of leverage. Between 1880 and 1980, private debt in the UK fluctuated as a percentage of GDP, but it never once reached 75% of GDP. But in 1982, both household and corporate debt took off. In 1982, total private debt was equivalent to 61% of GDP, split equally between households and corporations. 25 years later, as the global financial crisis unfolded, private debt was three times larger at 197% of GDP, again split 50:50 between households and corporations.

The key changes to legislation that occurred in 1982 is the UK let banks muscle into the mortgage market that was previously dominated by building societies. This was sold in terms of improving competition in the mortgage market, to the benefit of house buyers: allegedly, mortgage costs would fall. But its most profound impact was something much more insidious: it enabled the creation of credit money to fuel rising house prices, setting off a feedback loop that only ended in 2008.

Building societies don’t create money when they lend, because they lend from a bank account that stores the accumulated savings of their members. There’s no change in bank deposits, which are by far the largest component of the money supply.

However, banks do create money when they lend, because a bank records a loan as their asset when they make an identical entry in the borrower’s account, which enables the property to be bought. This dramatically inflates the price of housing, since, as the politicians themselves acknowledge – housing supply is inflexible, so prices increase far more than supply.

The supply side of the housing market has two main factors: the turnover of the existing stock of housing, and the net change in the number of houses (thanks to demolition of old properties and construction of new ones). The turnover of existing properties is far larger than the construction rate of new ones, and this alone makes housing different to your ordinary market. The demand side of the housing market has one main factor: new mortgages created by the banks.

Monetary demand for housing is therefore predominantly mortgage credit: the annual increase in mortgage debt. This also makes housing very different to ordinary markets, where most demand comes from the turnover of existing money, rather than from newly created money.

We can convert the credit-financed monetary demand for housing into a physical demand for new houses per year by dividing by the price level. This gives us a relationship between the level of mortgage credit and the level of house prices. There is therefore a relationship between the change in mortgage credit and the change in house prices. This relationship is ignored in mainstream politics and mainstream economics. But it is the major determinant of house prices: house prices rise when mortgage credit rises, and they fall when mortgage credit falls. This relationship is obvious even for the UK, where mortgage debt data isn’t systematically collected, and I am therefore forced to use data on total household debt (including credit cards, car loans etc.).

Even then, the correlation is obvious (for the technically minded, the correlation coefficient is 0.6). The US does publish data on mortgage debt, and there the correlation is an even stronger 0.78—and standard econometric tests establish that the causal process runs from mortgage debt to house prices, and not vice versa (the downturn in house prices began earlier in the USA, and was an obvious pre-cursor to the crisis there).

None of this would have happened – at least not in the UK – had mortgage lending remained the province of money-circulating building societies, rather than letting money-creating banks into the market. It’s too late to unscramble that omelette, but there are still things that politicians could do make it less toxic for the public.

The toxicity arises from the fact that the mortgage credit causes house prices to rise, leading to yet more credit being taken on until, as in 2008, the process breaks down.

And it has to break down, because the only way to sustain it is for debt to continue rising faster than income. Once that stops happening, demand evaporates, house prices collapse, and they take the economy down with them. That is no way to run an economy.

Yet far from learning this lesson, politicians continue to allow lending practices that facilitate this toxic feedback between leverage and house prices. A decade after the UK (and the USA, and Spain, and Ireland) suffered property crashes – and economic crises because of them – it takes just a millisecond of Internet searching to find lenders who will provide 100% mortgage finance based on the price of the property.

This should not be allowed. Instead, the maximum that lenders can provide should be limited to some multiple of a property’s actual or imputed rental income, so that the income-earning potential of a property is the basis of the lending allowed against it.


Two smaller points first: Steve doesn’t mention the role of ultra-low rates. Which is a huge factor leading the process. Second, he says his proposals will “..transition us from a world in which we treat housing as a speculative asset rather than what it really is, a long-lived consumption good”. I wonder if perhaps we should take this a step further.

We don’t see land as a consumption good either, or water sources. They are assets that belong to a given community. Or should. So shouldn’t buildings be too? A building society (or some local equivalent, It’s a Wonderful Life style) in a community can’t, won’t lend out money to build homes that serve the interests of the owner, but hamper those of the community. But now I sound even more commie than Steve for many, I know.


On to my main point: if you return mortgage lending to money-circulating building societies, rather than money-creating banks, who’s going to create the money? Don’t let’s forget that a huge part of our present money supply comes from those banks, and much of that from the mortgage loans they issue. Steve may well have thought about this (was he afraid to ask?), and I’d be curious to see his views.

Inflation/deflation is a function of money supply x money velocity (MxV). There are multiple ways to define this, and discuss it, but in the end this remains valid.

This is what the US money supply (stock) has done over the past 30-odd years



And here is the Case/Shiller home price index for the US over roughly that period. The correlation is painfully clear. Except maybe for that drop in 2008, but the Fed caught that one. Can’t let the money supply fall off a cliff.



And why can’t we afford to let the money supply fall off a cliff? Because money velocity already has:



How dramatic that fall has been is perhaps even clearer on a shorter time-frame.



We can say that MV = GDP, or we can make it a bit more complex with MV=PT, where P is prices and T is transactions (or national output), and people can say that this is just one of many ways to define inflation, but when you have a drop in velocity as steep as that one, and you combine it with the rise in money supply we saw, the danger should be obvious.

We have made our economies fully dependent on banks creating loans out of thin air. Which is a ridiculous model, and as Steve says: “That is no way to run an economy”, but we still have. And if and when home prices start to fall, and fewer people buy homes, the money supply will first stop rising, and then start falling, and we will have the mother of all deflations.

If you take the MV = GDP formulation, GDP will go down right with the money supply, unless velocity (V) soars. Which it can’t, because people are maxed out on those mortgages. They can’t spend. If you go with MV=PT, then if money supply falls, so will prices. Unless transactions (output) is demolished, but that will just kill off velocity even more. Why many people see inflation in our future is hard to gauge.


We could, presumably, get our central banks to pump ginormous amounts of money into our societies, but where are they going to put it? Not into our banks(!), which wouldn’t create all those loans anymore, as It’s a Wonderful Life takes over that role, taking the banks and their present role down with it.

Because it’s starting to get obvious that the present ‘system’ is set to go down big time, since as Steve put it:the only way to sustain it is for debt to continue rising faster than income, and we all know where that goes, we can advocate a version of controlled demolition, but who would lead that?

The banks are the most powerful party at the table right now, and controlled demolition of what we have today, as sensible as it may be for society at large, is not for them. Which makes this not only a financial problem, but a political one too: where does power reside. Down the line, it doesn’t even seem to matter much who gives out the loans, there will be very few takers.

Let’s just say we’re open to suggestions. But they better be good.



Home Forums The Mother of All Deflations

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    Keith Haring Retrospect 1989   Longtime and dear friend of the Automatic Earth, professor Steve Keen, wrote an article recently that everyone sho
    [See the full post at: The Mother of All Deflations]

    Dr. D

    Again Keen is correct as far as it goes, and that’s why we haven’t had inflation. If I print billions but hide it under a rock, is that inflationary?

    But not forever. There are several styles of inflations, created by interactions of the few moving parts (to paraphrase Jimmy Carter). There are war inflations, shortage inflations, and seldom but sometimes, overheating economy inflations. “Inflation” itself refers to the ‘increase-in-the-money-supply’ rise in prices.

    But “inflation”, as we hear of it, hyperinflation is not these things. It’s total loss of confidence in the government or the government/economy combo. The people repudiate the currency and look for alternatives, leading to bad wrangles with the government. In Weimar, the classic example, the government printed enormous quantities of money with no ill effects for years…until they didn’t. Then suddenly, in a few weeks, what worked for the previous 2 years stopped working before the Bank could respond or figure out why.

    There’s a Twitter meme on this today I can’t find.

    This is pretty common of hyperinflations. Seems like today they can stretch them out longer–first in slowing the event, then like Argentina, keeping it going for years, not months.

    So I’d expect a repudiation of the US$, or even the UK Pound, but not internally at first, and not from the West. From China vs the West in imports, then leading to problems that can’t be contained, finally arriving with the people too.

    Again, hyperinflation is strangely the LACK of money. Prices rise and people are desperate to get currency to pay bills at the same time. The economy slows and tanks and does NOT increase (opposite of some other inflations) yet import costs and lack of confidence leads to prices and velocity increasing.

    People trapped in the spiral look for gold, nearby currency (US$ in Argentina), and now cryptos, as in Venezuela today. It ends when the government gives up their bad behavior and allows the free market to work again. Confidence returns, but no one trusts the currency and it has to be backed with something tangible, usually gold (which is an international good). Then the whole thing starts again.

    Deflation now? Sure. Always? Maybe not. Fiat has always ended in repudiation, but the Core currency is always the last to fail.


    Steve Keen examines the available data and finds it supports his claim that mortage credit expansion drives house prices rises. I agree with him that it does, and I think I know what the causal mechanism is (as in my recent post to this thread).

    But why are things set up like that? What’s the motive?

    It’s this. Credit expansion benefits two groups: banks and debtors. Banks like credit expansion because each new loan issued is money they create out of thin air and add to their books as an asset. Debtors like credit expansion because creating new money (i.e. inflating the money supply) devalues the currency – and with it their debts.

    This is the crux of the matter: Governments are by far the world’s biggest debtors and they also have the power to set the monetary policy that allows banks to expand credit.

    That toxic symbiosis between banks and government is the nub of the problem and neither of them is going to change it voluntarily.

    Diogenes Shrugged

    The problem will be lack of money, even total absence of money in many households. If a deflationary period is severe enough, those without money will find a substitute. Barter presents obvious difficulties as goods’ worths are mismatched, so local, temporary forms of currency will be invented. Unless, of course, a better alternative to the dwindling supply of fiat already exists. Like, for instance, Bitcoin.

    Which causes me to question whether a deflation can simultaneously be a hyperinflation, as one event, not two separate events. An increasing loss of confidence in the national currency because of its sheer unobtain-ablity.

    Apologies if all of this has already been written about and discussed; if so, I’ve somehow managed to miss it.

    Not bothering to cite sources here, but I’ve gotten the impression that the initial replacement currency governments (i.e. banks) come up with often turns out to be a dud. That first attempt at a new currency ends up ruining everybody who accepts it. Currently in vogue with governments (i.e. banks) are the planned blockchain-based replacement currencies, all centralized so as to provide a smooth transition for the currency controllers. New digital currency, same as the old digital currency, but winning acceptance from the ignorant and gullible public by using the magic word “blockchain.” Oh, they’ll work for a while, but all will fail, probably within a few years.

    In 2003, I told a colleague we’d never in our lives ever see gold that cheap again. I’ve been right so far in that prediction. Well, it’s 2018 now, and FWIW I’m telling my colleagues we’ll never in our lives see Bitcoin this cheap again. If this blog is still up in fifteen years, consider this a warning. I plan to gloat.

    Diogenes Shrugged

    Clarification: In absolute numbers, BTC might well be cheaper later on, but after factoring in the coming escalation in dollar purchasing power, I’m sticking to my prediction.


    Steve Keen is clearly controlled opposition meant to make people like Ilargi feel good. I know this will hurt emotions, but the FACTS are clear.

    The Principle and Interest on Debt Myth

    The above article used to have comments attached to it. Forbes took them down.
    Read the article.

    In it, Keen has the Banksters making the most money even though they do effectively nothing but key money into the system and call it back in. There was no criticism of this in his article. He’s apparently fine with it.

    But that’s not the worst part. His depiction of the money system is that of a finite zero-sum game, and it is exactly correct. That’s what a debt-money system is: money assets = money liabilities.

    Keen’s argument is that there is actually equality between money owed and money available, and in this argument he’s exactly right.

    But, alas, Orwell spilled the beans. Orwell told us all that omission is the most powerful form of lie.
    What did Keen omit? That in order for the debts to be payable, the banking sector needed to provide two conditions:

    1. Absolute perfect money flow to debtors before their debts were due (the existence of money isn’t the issue, the availability of money to the debtor in a timely manner IS the issue).
    2. The Banking sector has to work with effectively zero net money. Why? If they have a net positive money condition, BY DEFINITION, IT IS EQUIVALENT TO A NET INEXTINGUISHABLE DEBT CONDITION ELSEWHERE IN SOCIETY. In fact, it is much worse than described. Why? Because it isn’t just the banks that have to operate this way, it is the Mega-Corporatocracy as well.

    Keen was made aware of the trillions held offshore (by definition inextinguishable debt).

    Did Keen answer incisively and honestly? Pfffffft. He didn’t answer at all (what could he do except admit the foundational fraud of the system, which he simply wasn’t willing to do?)

    He LIED and said the facts weren’t accurate, and said he’d devise a more “complex” model (the truth is simple, Keen – 5th grade mathematics… THE LIE MUST BE COMPLEX!). He LIED about that, claimed a new model wasn’t required, declared the debate settled, and moved on.

    Forbes eventually destroyed the comments section.

    But Steve Keen makes Ilargi **FEEL** good, so Ilargi won’t go near the tyranny inadvertently exposed by Keen’s little model.


    Poverty – Debt Is Not a Choice

    How To Be a Crook


    Yes, Keen is right there will be a deflation.

    Keen’s job is to make it look like something other than it is, a systematic military operation being purposefully run by Money Power Sith Lords against their ordinary human prey (oligarchs vs. serfs, same ole, same ole… Keen is just a level of Goebbels*).

    “The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”
    ~Lord Acton

    “The new law will create inflation whenever the trusts want inflation. From now on depressions will be scientifically created.”
    ~Congressman Charles A. Lindbergh, after the passage of the Federal Reserve act 1913.

    Keen is called “controlled opposition.”

    * And yes, the comparison is more than fair… the human death and misery directly caused by debt-money induced poverty is orders of magnitude larger than the death toll cause by the Nazis… and that is NOT hyperbole. That is FACT. And Keen protects this weapon that starves 10s of millions to death every year…


    >>Again Keen is correct as far as it goes, and that’s why we haven’t had inflation. If I print billions but hide it under a rock, is that inflationary?<<

    But when Keen was confronted with the finite zero-sum nature of debt-money in the article I linked above, he claimed that money is not “hidden” and is always available in the amounts needed by debtors.


    While I have some opinions on Steve Keen, one is not that he’s stupid or intellectually challenged. In fact, I think he’s intellectually gifted. The problem is, a literal 5th grader has seen what he claims to be unable to see…



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