How to Avoid Another Financial Crisis
Written by Alfonso Elizondo
In his book entitled Can We Avoid Another Financial Crisis? Steve Keen says that this is not possible, so we won’t have to wait long before the next explosion hits. The world’s leading economists did not anticipate the subprime meltdown because they all believed in the chimera known as 'The Great Moderation' and they had become a egotistical group, eager to dominate political discussions, but far removed from the real world.
Last year Paul Romer, a distinguished economist at the World Bank, accused his colleagues of forming an intellectual community that rejected the arguments for austerity and ignored the opinions of those who were not part of their group. Romer said that the preference for the new high-theory mathematical models meant that the economy had been based on a series of dubious assumptions. So crises were impossible in that created paradise and the final outcome was impossible to predict.
Like Keen, Romer agrees that the most serious mistake of the new macroeconomy is that it ignores finance. Money is seen as a veil that covers the activities of the real economy and as a resource to get around the inconveniences of bartering.
At the same time, traditional economists saw capitalism as a complex financial system in which money and credit were intertwined. They thought that financial transnational corporations depend on financing.
Those who paid close attention to credit, as Keen did before 2008, noted that credit had risen very fast in the US, Australia and much of Europe. So Keen pointed out at that time that a credit crunch was not necessary in order to bring about a major deceleration of the economy; all that was required was a lowering of lending rates. This was proven in 2008 when credit slowed down abruptly and led the US into a big slump.
Keen is now calling for the current macroeconomic models to be scrapped and replaced by others that take credit into account. In his book he developed a macro model based on credit. Economists at the Bank for International Settlements have developed a 'financial-cycle’ model along similar lines. And it was observed that in the end macro models without money do not work.
So the final question would be: When will the next crisis be? With his eye on China's credit growth, Keen says he thinks this is a terminal case. China has increased its credit to 25% annually for many years and private sector debt is higher than 200% of GDP, similar to that of Ireland and Spain in 2008 but much more important for the global economy. Keen says that this huge bubble has to burst very soon, causing an unprecedented global crisis.
Addendum: It is obvious that we are going through a new phase in human society in which all historical precedents are of very little use. Now it’s the present and the immediate that are paramount.