Why Keynesian voodoo doesn’t work?


Keynesian policy of manipulating economic “aggregates” through countercyclical macro-measures appeared to work when balance sheets was not stretched to the brink. As we wrote in “Goebbelnomics

“If collective exuberance and apathy is the sole cause of the business cycle, then it logically follows that human emotions need to be manipulated accordingly. Only by doing so can policymakers smooth out the ups and downs in economic activity. And what better way to do that then to change the money supplied to the general public.” 

While people called this the “most sickening article ever written” it is unfortunately what economics has come down to. Through fractional reserve banking and a central bank freed from the shackles of a barbarous relic, the money supply can be expanded without limit…or at least as long as the greater populace voluntarily will leverage up their balance sheet to buy stuff and simultaneously agree to their own servitude. Nothing more than collective manipulation on a scale that would make Goebbels himself envious.

The glaringly obvious result of such policies, gross capital consumption through malinvestments epitomized through a serial bubble economy, did not discourage our money masters. The best and brightest even suggest bubbles are the only remedy to what they believe is some sort of secular stagnation.

Just as drugs, the abuser must increase the dosage to feel the same high and spend accordingly.

However, as the first chart shows, the current recovery, albeit one of the longest on record, has also been the weakest.

Expansion_weakSource: NBER, BEA, Bawerk.net

This obviously haunt our money masters as unprecedented amount of fiscal and monetary stimulus should have brought about a strong economy. The idea was always to condition debt addicted households to once more drool over available debt like secretion coming from Pavlov’s dogs on the mere sight of low interest rates and quantitative easing.

Empirically inclined pundits point to the pre-crisis period and do not understand why the economy does not behave similar today. All economic models tell the experts that low interest rates and a booming stock market boost the wealth effect through higher asset prices and hence lead to higher consumption and presto a booming economy. Per the latest flow of funds account US households has actually experienced a 42 per cent increase in their asset values since 2009, but still refuse to go on a spending spree.

In what was later dubbed the “jobless recovery,” whatever that may be, the noughties boom was to a large extent based on balance sheet expansion which flattered gross domestic production numbers and played conveniently into the great moderation bull-crap.

Our second chart show how household’s liabilities compare relative to their income over the business cycle. Unsurprisingly two cycles stand out; prior to the worst financial crisis since the 1930s US households went all bananas. Total leverage, above nominal income, rose more than 46 per cent. In other words, US households increased their liabilities from $7.3tr to $14.4tr, a 95 per cent increase while income on the other hand only rose along with nominal GDP, from $7.7tr to 10.7tr, a 39 per cent increase. In no circumstance have this happened before.

After the crisis US households were less inclined to spend frivolously even though Bernanke et al. told them to do so, for free. On the contrary, US households stopped the insanity and actually tried to realign income and debt at a more sustainable level.

chg household debt

Source: NBER, Federal Reserve (Z.1), Bawerk.net

As David Stockman never tires of telling us, and rightfully so, the US economy has reached peak debt and the law of diminishing marginal utility applies to debt as much as any consumer good.

Despite futile attempts to disprove it, higher debt levels does lead to lower growth and the reason is simple. Every added percentage point of debt – over GDP – must by definition be less productive than previously added debt. As more and more debt accumulates the economy must support debt that at some point subtract from production.

For example, going to Spain on your credit card to enjoy Costa del Sol and a drink or two does not add to the productive capacity of society, but must instead be repaid to society through work completely unrelated to the debt that funded the vacation. If society creates a financial system, and incentive system, which encourages such behaviour it is reasonable to expect a market correction. As a matter of fact the sooner unsustainable activities loose access to funding the better. That a construction company in Ireland cannot get funding to build more condos is not a bad thing, it is what makes a capitalistic society survive. Note, the Soviet Union experienced a Great Moderation and had only one recession in 70 years. Unfortunately for them, the 1990 recession was quite brutal.

As our last chart shows, peak debt has indeed reached the US (and Europe, and Japan, and China and Australia….) and every attempt to boost GDP, income and employment by increasing leverage even further is doomed and always was.

A deflation so severe that it brings total debt back to its long term average of around 150 per cent of GDP is the only thing that can lead to sustainable growth, free of bubbles and secular stagnation. That this is politically and socially unacceptable makes us wonder how we will solve this pickle. Still, only by doing so can we free ourselves from the circular logic baked into today’s economic theory;

increase leverage –> increase GDP –> make leverage sustainable –> increase leverage further

tot debt

Source: Historical Statistics of the United States; Colonial Times to 1970, Federal Reserve (Z.1). Note, we have used banks’ balance sheets as proxy to estimate private debt from 1834 to 1915.




  1. I have been looking for data on total US debt from before 1916 for years!!! Thank you so much.
    I will have to look for bank balance sheets in the old Historical Statistics.
    Wondering if you have a link identifying the source data for your debt & GDP graph there.

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