Inquiring minds are watching Australian economist Steve Keen correctly debunk Paul Krugman in an interview with Lauren Lyster on Capital Account. Unfortunately, Keen's solution to the debt crisis leaves a lot to be desired.



Position of Keen

"Debt does not just matter at zero-bound conditions, debt matters all the time. The change in debt adds to demand. ... It could take 15 years of deleveraging before it's all over. That's why Krugman is wrong. You can't just cure this with deficit spending, you have to abolish the private debt as well."

So far so good. However, I strongly disagree with Keen's proposal of a "private debt-jubilee" which he defines as quantitative easing for the public.

Essentially Keen wants to print money and give it to the public on the provision they must pay down debt first.

Debt Jubilee Nonsense

Suppose everyone is given a "debt-jubilee". What is to stop consumers from immediately going back into insane levels of debt? More regulation? Government controlled printing presses? Academic formulas from all-knowing economists?

Please! Stop already.

Inflation Genie

I am in general agreement with Keen on numerous things.

For example, I agree 100% with Keen that lending comes first and reserves later. I also agree with Keen that the notion of excess reserves is fatally flawed, and so is the notion of money multipliers.

I scoff, along with Keen, with the idea that excess reserves are going to come pouring back into the economy causing hyperinflation or massive inflation.

For a discussion, please see my December 21, 2009 article Fictional Reserve Lending And The Myth Of Excess Reserves in which I rebut the idea espoused by Robert Murphy that the Inflation Genie is About to Get Out of the Bottle.

The idea was silly then and it is still silly now. I believe events have proven as such.

However, start giving money away as Keen proposes and I would change my tune about inflation in a hurry. Note that QE is essentially a loan but Keen's proposal is an outright gift.

Case For Deflation

Mind you there is absolutely nothing wrong with price deflation.

Who out there does not want the price of oil to drop or the price of food to drop? Who does not want more for their money at the department store? Who does not want the price of a college education to drop?

The answer to that last question is public unions, administrators, and for profit colleges. The answer to the above questions in general is those with first access to money, notably banks (and bank CEOs and executives who get paid to make more and more loans).

Free Market Economy

In a free market, the cost of an education would plunge like a rock. Internet services would spring up all over the place providing quality education. Absolving student debt or any other debts cures no structural problems.

More government and more regulation is not the answer. Nor is more Fed the answer. Nor are models. Nor is giving money away any part of the solution.

Big Fan of Keen

Bear in mind that I am a big admirer of Steve Keen. Steve has taught me a lot. I like his debt model. I just do not like his solution. It cannot and will not work, for reasons that quite frankly should be obvious.

Real Solution

Fractional reserve lending is at the very heart of the debt crisis. That is what enables banks to conjure up credit at will (as long as they are not capital constrained and as long as consumers and businesses want to borrow).

The solution therefore, is not free money and not more government intervention into free markets, but rather sound money and less government interference, coupled with the end of fractional reserve lending.

Yes, it will take time. Attempting to short-circuit the time required with "free money" would be a monstrous mistake, solving zero structural problems.