ABC PM Debate with Chris Caton

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ABC Radio’s pre­miere cur­rent affairs pro­gram PM asked me to debate the caus­es and impli­ca­tions of last week’s mar­ket sell-off with Chris Caton, from BT Aus­tralia. Click below to hear the debate.

Steve Keen’s Debt­watch Pod­cast

The tran­script is below  (and here on the ABC site). As is usu­al with such things, the tran­script is wild­ly ungram­mat­i­cal at times.

MARK COLVIN: The under­ly­ing fact about the glob­al econ­o­my is that there’s still a huge dis­crep­an­cy between what the eco­nom­ic his­to­ri­an, Niall Fer­gu­son, calls Plan­et Finance and Plan­et Earth.

After the glob­al finan­cial cri­sis, he told this pro­gram that the true GDP of Earth was 10 times less than the val­u­a­tion that Plan­et Finance put on it. A cou­ple of years lat­er he said it was down a bit, but Plan­et Finance was still sev­en times over­val­ued. Anoth­er way of describ­ing this is a bub­ble — and bub­bles that aren’t prop­er­ly pricked keep re-inflat­ing.

Plen­ty of econ­o­mists have been point­ing this out over the last few years and this year with the US debt debate and the Euro cri­sis, peo­ple have been say­ing it ever more fre­quent­ly. In some ways one of the few mys­ter­ies is why the mar­kets have sud­den­ly cho­sen this time to lis­ten.

I’m joined in the stu­dio by Steve Keen, asso­ciate pro­fes­sor in eco­nom­ics, from the Uni­ver­si­ty of West­ern Syd­ney, and on the phone Chris Caton, chief econ­o­mist of the BT Finan­cial Group.

Chris Caton, you watch the mar­kets, why now, I mean why not three weeks ago or three weeks from now?

CHRIS CATON: Well there isn’t a good rea­son. I sup­pose the cat­a­lyst, well we’ve had two cat­a­lysts, cer­tain­ly in the US.

Num­ber one, the ago­nis­ing about the debt ceil­ing, would it be raised? Was there a chance of default? Was there a chance of down­grade? That’s cat­a­lyst num­ber one.

And cat­a­lyst num­ber two, there has been just a rapid-fire series of very weak eco­nom­ic data points: the GDP reports for the sec­ond quar­ter, the pur­chas­ing man­agers sur­vey that cov­ers man­u­fac­tur­ing, and news about real con­sump­tion growth in recent months. And of course on top of that, you know, renewed rum­blings about euro­zone debt.

This could have hap­pened at some oth­er stage, but to me those were the cat­a­lysts. Cat­a­lysts don’t cause things, they just bring them on if you like.

MARK COLVIN: And some of it is just sen­ti­ment, as they call it in the mar­ket, in oth­er words a sort of skit­tish­ness I sup­pose?

CHRIS CATON: Absolute­ly, when­ev­er these things start they always con­tin­ue essen­tial­ly because, well you can call it pan­ic, you can just call it peo­ple try­ing to get out, but yes pan­ic sets in.

MARK COLVIN: Steve Keen is this the begin­ning of anoth­er glob­al finan­cial cri­sis?

STEVE KEEN: It’s the con­tin­u­a­tion of the last one. I mean Chris is quite right to say that there are cat­a­lysts and there are caus­es, and he’s iden­ti­fied a cou­ple of impor­tant cat­a­lysts as to why it hap­pened now.

But the real cause is what’s hap­pen­ing with pri­vate debt. This is being ignored in all the bal­ly­hoo over the lev­el of gov­ern­ment debt in Amer­i­ca right now but this is always been a cri­sis caused by pri­vate debt, which fuelled the biggest stock-mar­ket bub­ble in his­to­ry, begin­ning back around 1994, and going right to 2000.

MARK COLVIN: What do you mean by pri­vate debt? Just explain what pri­vate debt con­sists of.

STEVE KEEN: Bor­row­ing by house­holds and cor­po­ra­tions and that’s what…

MARK COLVIN: So we’re all in it, I mean this is about our mort­gages too?

STEVE KEEN: Yeah mort­gages actu­al­ly drove up the lev­el of house prices obvi­ous­ly. But equal­ly finan­cial-sec­tor bor­row­ings and lend­ing to mar­gin­al loans and stuff like that, actu­al­ly drove up the stock mar­ket as well. And to have a ris­ing set of asset mar­kets, you don’t just need ris­ing debt you need accel­er­at­ing debt.

And that’s what’s been going on in Amer­i­ca for the last 20 years and it’s been com­plete­ly ignored by the Fed­er­al Reserve. They actu­al­ly, and now the decel­er­a­tion is what actu­al­ly set the finan­cial cri­sis in train.

MARK COLVIN: Is there a hous­ing bub­ble in South-East Asia as well, or in Asia gen­er­al­ly?

STEVE KEEN: I think Asia had its huge cri­sis back in 97/98 and…

MARK COLVIN: I’ve just seen stuff in recent days sug­gest­ing that…

STEVE KEEN: There seems to be a yeah. Every time the finance sec­tor gets away with a par­tic­u­lar explo­sion in debt, as you said with Niall Fer­gu­son’s work, it gets back to it again if you don’t com­plete­ly put them back inside their box­es.

And not only did we not put them back inside the box, we put them in the gov­ern­ing seat and spent most of our time try­ing to res­cue the finan­cial sec­tor that caused the trou­ble in the first place.

MARK COLVIN: Chris Caton is this the exten­sion of the glob­al finan­cial cri­sis?

CHRIS CATON: It’s the hang­over after the drunk­en binge in my view. So yeah, it is still essen­tial­ly caused by every­thing that brought the GFC on.

MARK COLVIN: A hang­over you can get over, can we get over this in, obvi­ous­ly not in a day or two which you can with a hang­over, but the glob­al equiv­a­lent?

CHRIS CATON: Yes. It’s my belief, and this is where I think Steve and I will prob­a­bly dis­agree, yes you can get over it, but you get over it only slow­ly.

And yeah I must admit it’s dif­fi­cult look­ing for­ward to see any­thing oth­er than, you know, fis­cal aus­ter­i­ty and con­sol­i­da­tion around the world, slow growth for a long time. So the hang­over’s going to last a long time, but to me we’re not, mix­ing metaphors just slight­ly, we’re not about to fall off anoth­er precipice.

MARK COLVIN: Do you agree with Ken­neth Rogoff, the pro­fes­sor of eco­nom­ics at Har­vard Uni­ver­si­ty, who says that the world is just basi­cal­ly still gross­ly over-lever­aged?

CHRIS CATON: I don’t see it quite that way, but I’m sure that Steve would have a dif­fer­ent opin­ion. I think that a lot of that…

MARK COLVIN: He’s nod­ding vig­or­ous­ly and he’ll come in in a minute.

CHRIS CATON: (laughs) I think a lot of that has gone away. But, yeah, it is quite clear there are still some stu­pen­dous­ly wrong val­u­a­tions, if you like. I don’t see that, inci­den­tal­ly, in the equi­ty mar­ket which of course is where we’re see­ing a lot of action late­ly.

Over to Steve …

MARK COLVIN: Steve Keen.

STEVE KEEN: (laughs) Well in terms of the lev­el of debt we’re in, if you go back to the begin­ning of the post-war peri­od in Amer­i­ca, Amer­i­ca’s pri­vate debt to GDP ratio was 45 per cent. It peaked out in 2009 at 300 per cent, so more than six times as much debt com­pared to income as when the Sec­ond World War end­ed.

And that’s now turned around, you’ve fall­en from 300 per cent of GDP as the pri­vate debt lev­el to 260 per cent, which is a pret­ty huge fall, but it still leaves Amer­i­ca with more debt than it had at the absolute peak of the Great Depres­sion.

MARK COLVIN: Does­n’t Pro­fes­sor Rogoff give a tip­ping point of 90 per cent?

STEVE KEEN: He’s talk­ing about gov­ern­ment debt.

MARK COLVIN: Right ok.

STEVE KEEN: I’m talk­ing about pri­vate debt.

MARK COLVIN: So where are we on that?

STEVE KEEN: Gov­ern­ment debt we’re hit­ting about the 100 per cent lev­el again.

MARK COLVIN: So they’re 10 per cent over his tip­ping point?

STEVE KEEN: But it would­n’t mat­ter if it was­n’t for the lev­el of pri­vate debt. The Amer­i­can gov­ern­ment began with a high­er debt to GDP ratio than 100 per cent after the Sec­ond World War, but the pri­vate sec­tor was at, you know, a triv­ial lev­el of debt, frankly, for Amer­i­ca’s debt-car­ry­ing capac­i­ty. So it was quite pos­si­ble for the pri­vate sec­tor to boom, and with the boom­ing pri­vate sec­tor the gov­ern­ment to grad­u­al­ly reduce its debt lev­el by run­ning sur­plus­es.

MARK COLVIN: So this does go back to the pre­vi­ous glob­al finan­cial cri­sis, it does go back to that peri­od where there were those com­pa­nies that were over-lever­aged, and peo­ple try­ing to make a nest-egg for their retire­ment were invest­ing in firms like Lehmans, and so forth, and also invest­ing in CDOs (col­lat­er­al­ized debt oblig­a­tions), those ter­ri­ble instru­ments which real­ly basi­cal­ly were instru­ments of…

STEVE KEEN: Mass destruc­tion.

MARK COLVIN: …instru­ments of mass destruc­tion, but what they rep­re­sent­ed was mort­gages that were nev­er, ever going to be paid back. And all that still has­n’t washed out of the sys­tem?

STEVE KEEN: It still has­n’t washed out. There’s still, I mean there’s lev­el of deriv­a­tives peaked at some­thing like $530 tril­lion, about three to four times the size of the glob­al econ­o­my, that peo­ple say that’s a gross posi­tion rather than net. But fun­da­men­tal­ly that only works if you can rely upon your coun­ter­par­ty not going bank­rupt. Well so much for that par­tic­u­lar reliance.

MARK COLVIN: Chris Caton, the counter argu­ment?

CHRIS CATON: Can I just say that in the long run there’s no mag­ic con­stan­cy between debt and GDP. For a start what you’re doing is divid­ing a stock…

STEVE KEEN: Oh please Chris don’t hit me with that one, that’s a sil­ly com­ment because the peo­ple did the same thing about gov­ern­ment debt and nobody ever whinges about that. It’s a blind spot neo­clas­si­cal econ­o­mists have about the lev­el of pri­vate debt because they believe the pri­vate sec­tor’s always ratio­nal, they’ve been through the biggest irra­tional bub­ble in his­to­ry.

MARK COLVIN: Let’s Chris …

CHRIS CATON: All I’m say­ing Steve is, you can make your same point if you like anoth­er way, but to me you real­ly have to look at the lev­el of debt and the lev­el of assets.

STEVE KEEN: Lev­el of assets have got three let­ters at the front ASS. I think we should take them impor­tant­ly. Assets can col­lapse in val­ue overnight, as we’ve seen today, you’re lia­bil­i­ties remain there, and it’s lia­bil­i­ties that are dri­ving this debt cri­sis.

They’ve got total­ly out of hand, and you, mate there may not be a mag­i­cal lev­el of debt, but when you have it going from 45 per cent of GDP to 300 per cent that is a run­away expo­nen­tial growth process that can’t be sus­tained. And when it broke that’s what caused the finan­cial cri­sis.

And we’re now in a per­ma­nent stage of delever­ag­ing until we get back down to sim­i­lar lev­els, about 100 per cent of GDP.

MARK COLVIN: Inci­den­tal­ly, since we’re talk­ing about valu­ing assets, to what extent are the rat­ings agen­cies at the cen­tre of this, as they were back in 2007 Chris Caton?

CHRIS CATON: They, well I guess the rat­ings agen­cies did­n’t dis­tin­guish them­selves.

STEVE KEEN: (laughs) I think they did.

CHRIS CATON: Well per­haps they did, but for the wrong rea­sons, dur­ing the GFC, and it may be that they’re a bit trig­ger hap­py right now and hence not help­ing mat­ters either. For exam­ple, this over­hang­ing threat to down­grade the US gov­ern­ment debt any­way, despite the, well despite what has been done there.

Now, you know, maybe US gov­ern­ment debt does deserve to be down­grad­ed, but there’s some­thing like 17 oth­er nations that have Triple‑A debt and when you look at them, you think, well sure­ly if the US, and maybe here again Steven might come in with this, sure­ly if the US deserves to lose its Triple‑A sta­tus, then all of the oth­er 17 do too. There’s not, nobody there whose debt should be more high­ly ranked than that of the US.

STEVE KEEN: Well I think the rea­son the USA gets away with it because it’s the reserve cur­ren­cy for the globe.

CHRIS CATON: Mmm.

STEVE KEEN: And of course also it’s got a cap­tive cen­tral bank. So if it runs a deficit and it can’t sell the bonds the Fed­er­al Bank, the Fed­er­al Reserve, nec­es­sar­i­ly under­writes it. The rea­son we’re get­ting a debt cri­sis, a gen­uine one, in Europe, rather than Amer­i­ca, is because they don’t have a cap­tive cen­tral bank. In fact, frankly, they don’t real­ly have a cen­tral bank at all.

MARK COLVIN: Alright, let me, we ought to wind up grad­u­al­ly.

Chris Caton, what do you think are the chances of avoid­ing stagfla­tion and what should we do about it?

CHRIS CATON: Well there’s no infla­tion to be stagfla­tion. The…

MARK COLVIN: In Aus­tralia, what about the world?

CHRIS CATON: Well the issue is avoid­ing …

STEVE KEEN: Defla­tion, debt defla­tion.

CHRIS CATON: …I would say we’re 80 per cent like­ly to avoid a dou­ble-dip reces­sion in, well either in Europe, or the US, or the world in gen­er­al. It is clear this is a peri­od that the world econ­o­my has lost a lot of momen­tum. My sus­pi­cion is that this is a tem­po­rary thing it’s going through.

MARK COLVIN: Steve Keen?

STEVE KEEN: I think it’s per­ma­nent until the debt lev­els are paid down. We’re in a debt defla­tion where delever­ag­ing by the pri­vate sec­tor is going to reduce aggre­gate demand below aggre­gate sup­ply and will slow­ly grind down.

MARK COLVIN: And the ques­tion of what we do about it?

STEVE KEEN: We have to abol­ish the debt. The debt should nev­er have been issued in the first place and the finan­cial insti­tu­tion that issued should go bank­rupt.

MARK COLVIN: And for Aus­tralia, the ram­i­fi­ca­tions and what we should do?

STEVE KEEN: Sim­i­lar sort of thing. We had equal­ly a big­ger hous­ing bub­ble, house debt bub­ble, than Amer­i­ca had, and that debt should nev­er have been issued, so we have to get that debt reset oth­er­wise we’ll face the same sort of grind­ing future Amer­i­ca has.

MARK COLVIN: And you’ll be on top of Mount Kosciusko again?

STEVE KEEN: No, no, I’ll be show­ing Rory Robert­son how to run.

(Chris Caton and Mark Colvin laugh)

MARK COLVIN: Chris Caton your pre­scrip­tions?

CHRIS CATON: Well I thought I just basi­cal­ly, I mean I think we will get through this very, but get through it very slow­ly and I just won­der…

MARK COLVIN: I mean for the gov­ern­ment, what would you be advis­ing the gov­ern­ment on how to buck­le up for this one?

CHRIS CATON: Well prayer I guess would be the first thing…

(Steve Keen and Mark Colvin laugh)

MARK COLVIN: Prayer, right…

CHRIS CATON: … and also …

MARK COLVIN: We’ll call in Car­di­nal Pell and Arch­bish­op Jensen.

CHRIS CATON: Aus­tralia has no endem­ic prob­lem here, we’re look­ing a paragon com­pared with every­body else.

STEVE KEEN: Not with our pri­vate debt lev­els.

CHRIS CATON: And we’ve also got more flex­i­bil­i­ty…

STEVE KEEN: That I’ll agree.

CHRIS CATON: …cer­tain­ly in mon­e­tary pol­i­cy than the rest of the world does. But we are not immune to what hap­pens else­where, we know that, so yeah, if the worst out­come were to come about else­where then we would be affect­ed, through loss of wealth, through con­sumer sen­ti­ment, etc.

MARK COLVIN: Thank you both very much.

Chris Caton, chief econ­o­mist of the BT Finan­cial Group and Asso­ciate Pro­fes­sor Steve Keen from the Uni­ver­si­ty of West­ern Syd­ney.