Transcription
Nations are drowning in debt. The world could soon owe more than it earns.
Our national debt is now larger than our entire annual economic output. There's going to be a government debt crisis in the near future. And I want to go through now and show why these warnings are completely wrong.
Meet Steve Keane. He's the world-class professor and famously predicted the 2008 global financial crisis years before it happened. Now he's lifting the hood on the GAO's terrifying debt projections to show the glaring mathematical blind spot the mainstream media completely missed. The USA currently has 31.5 trillion in public debt.
And that is something which instantly sounds boring. In fact, if you get this wrong, you make up myths about the economy. So you have to understand this is a serious warning. There's only one trouble. It's based on completely mythical, completely fallacious visions.
So the government accountability office has just published a report, uh, to Congress telling the Congress that unless there's urgent and sustained action to improve the fiscal outlook for the economy, there's going to be a government debt crisis in the near future. And their arguments summarizing and saying government debt is a share of the economy is projected to grow at an unsustainable rate. I mention government debt there because they don't mention that whether it's government or private. They simply talk about government debt as if that's the only form of debt, which is something that neoclassical economists in general do all the time.
And I want to go through, uh, and now and show why these warnings are completely wrong because economists do not understand money. Ridiculous, because everybody thinks economists are experts on money. But fundamentally, they don't include money in their macroeconomic models, and their arguments about money are based on fallacious concepts of how money is created.
But let's see what they're warning the, uh, the government of in America right now. And this is the same thing that is being told to the British government, to the Australian government, to the Spanish governments, all around the world are being told: government debt is dangerous, you must reduce it.
So the government accountability office has said that, uh, government debt will reach 106% of GDP, according to their projections, by 2029. It'll grow twice as fast as the economy over the next 10 years. And they claim in 30 years' time it'll hit 250% of GDP. So it's unsustainable for government. It's unsustainable for debt. And here they just by living out any word, all they're thinking of is government debt. Over the long term, it's unsustainable for government debt to grow faster than the economy grows.
This is the projections they, they're making. So they've got data up till 2026, and then they're projecting forward what they think is going to happen to government debt over the next 30 years. And you can see there've been rises and falls in government debt as a percentage of GDP from 1900 till today. But they simply project continued growth. And notice the ratio of government debt to GDP is rising exponentially. That's an exponential curve. It'll ultimately go almost totally vertical unless we do something about the level of government spending.
And equally, because you pay interest on government debt, they're making the same, uh, projections about what's going to happen to interest payments. So, they're saying the historical high was right back in the early 1990s when interest payments were 3.2% of, uh, GDP. Now they're at the same level and they project them to triple over the next 30 years. So this is a serious warning. There's only one trouble. It's based on completely mythical, completely fallacious visions of how money is created in a capitalist economy.
And this is not something specific to the government accountability office. This is something that all economists learn when they're at university. So this is an extract from Mankiw's textbook on macroeconomics. And just to read it through: "When the government spends more than it receives in tax revenue, the resulting budget deficit lowers national savings, the supply of what they call loanable funds." And fundamentally, you can regard that as the money that's in your bank accounts because that's the money you have available to lend out to somebody else. "The supply of loanable funds decreases. When the government borrows to finance a budget deficit, it crowds out firms that would otherwise borrow to finance investment."
And what they've, the simple supply and demand model that Mankiw uses to illustrate his argument argues that a budget deficit reduces the supply of loanable funds because it takes funds that households would have lent to firms and instead it goes to the government. So that is the mindset that all people who accept mainstream neoclassical economics have in their heads, and the people who staff the government accountability office are all predominantly economists. They learn this stuff, they think it's correct.
Now, the trouble is, it's not. They learn what they get taught at university, which uses supply and demand diagrams, as you saw in the extract from Mankiw. But banks don't draw supply and demand curves to decide how much money to lend to you. They use double-entry bookkeeping. And that is something which instantly sounds boring. You know, double-entry bookkeeping means accountants and all this dreadful dull stuff. In fact, if you get this wrong, you make up myths about the economy. So you have to understand double-entry bookkeeping to know how banks actually operate and how money is created in a capitalist economy.
So what double-entry bookkeeping does first of all is classify all financial claims as either financial assets or financial liabilities. Uh, and it records all transactions twice on each line. Once as a credit entry and once as a debit entry. That's what makes accounting very hard to learn. But you also record all transactions from two perspectives: between the creditors and the debtors. So each transaction requires at least two of what I call "godly tables" in Rell to show the overall dynamics.
Now, my side of economics, which goes right back to Joseph Schumpeter back in the early 1900s, and even earlier, back into disputes between, uh, different schools of economic thought back in the 1800s. My side has been saying that that's wrong. Okay? Banks are not intermediaries. Banks create money by creating debt. And that argument has only been made by critics of the economy, economics, for decades. But in 2014, the Bank of England actually came out and said that critics like me are right and the textbooks are wrong.
"In normal times at least, notes and reserves are determined by the amount of notes that people want people want to hold or need for their transactions, and the amount of notes and reserves that banks want to hold, given the level of interest rates in the economy. It is not chosen or fixed by the central bank, as is sometimes described in some economics textbooks."
So this report was published called "Money Creation in the Modern Economy," and it opened with the statement that "money creation in practice differs from some popular misconceptions. Banks do not act simply as intermediaries lending out deposits that savers place with them, and nor do they multiply up central bank money." So it's criticizing two models that economists use to purportedly describe the monetary system. One is called "loanable funds." The other's called the "money multiplier." The Bank of England has said both of those models are wrong.
And when you put this model together, you find that there's no particular impact of private debt on the economy. Well, if this video has alerted you to the fact that what you thought you knew about economics is wrong, you'll thoroughly enjoy the free book bundle that has been requested by over 5,000 people already. It's worth $50, but it's free right now. Click in the link in the description or go to stevekeen.com and click on the black button and fill in your information. About 60 seconds, you'll get the free book bundle. And after that, if you want to study with me personally and use my proprietary software Rell, there'll be an invite to join that course as well.
So this is showing the conventional model that banks are just intermediaries in Rell. And what I have is that there are two types of depositors in this model. There are savers who lend out money. There are borrowers who borrow that money and then use it for other purposes. The debt that's created through the banking system is not an asset of the savers. It is an asset of the banks, and it's quite easy to go through and modify this in Rell. If the, if the textbook model was right, then you would be correct to ignore private debt, but it's not correct. And I can easily modify that and say it's not true that debt is an asset of the savers, and it's not true that the savers lend the money and that the interest is paid to them. It's the banks that own the debt, and it's the banks that earn the interest income. So I can rapidly amend that.
And now I'm just going to say I'm not using the textbook model. So to simplify my presentation here, I'm just pretending that banks instantly spend their interest income. In the real world, they take time, but that would make a more complicated model. And I just want to focus on the essence of the reality that if you say that banks are not money creators, then you can ignore private debt in your models of the economy. But as soon as you realize that banks actually create money, that creates additional demand, and you cannot ignore the banking sector when you're looking at the macroeconomy.
So I've just changed that one detail. Let's now go over to the publication tab. And I'm going to start with zero lending. And of course, with zero lending, nothing happens. Well, let's say there's lending now, uh, you know, one $1 per year type lending. You get a rising level of money in the, in the borrower's accounts. The loan, the loans create deposits. The private debt ratio rises, but nowhere near as much as it did in the previous simulation, and GDP is rising. The government, the borrowing by the private sector creates money that causes additional economic activity, and GDP rises. Now, that's completely missed by the mainstream. They, they ignore the level of private debt.
Now, if you have at the same time, a lending that goes negative, which I'm showing now, then GDP falls. So if you ignore private debt, which neoclassical economists do unfortunately do, then you ignore the extent to which the economy's operation depends upon the level of credit creation by the private sector. So you can see in this very simple model, private debt goes up, so does GDP. Private debt falls, so does GDP. This is being ignored by the mainstream. So their advice about the private banking is completely wrong. Then, because banks lend, they create money as well as creating debt. That money turns over and causes more macroeconomic activity. So you can't ignore private debt and understand the macroeconomy.
But that is what all mainstream economists do, and they continue doing it even after they got caught by surprise by the global financial crisis, which was caused by private money lending. They didn't see it coming. They ignored the whole thing. They didn't see the damage that was going to do. And now they're continuing to advise us as if they're experts on the monetary system. So by ignoring private debt and obsessing about government debt, you'll see that they, this is the line they worry about. They're ignoring this one. They ignored it back at the time of the global financial crisis, which is here. They're still ignoring it today. They refuse to learn from history.
Now, why do they refuse to learn from history? Because history refutes their theory. And unfortunately, the way that academics in general behave, particularly those in the social sciences, is they ignore evidence which contradicts their, their belief system. They ignore anything that challenges their paradigm. Now, I've been publishing this chart for 20 years. Okay? And I've only had one or two economists ever even try to understand what's going on. And in the mental model that economists have, which they call "loanable funds," that's true because banks don't lend money. In the real world, they do. You take a look in the real world, and this is the pattern you see between credit and unemployment. They're virtually Siamese twins. One goes up, the other goes down. It's absolutely locked. Uh, rising credit causes falling unemployment. Falling credit causes rising unemployment. This is why the global financial crisis occurred. It's why the mainstream completely missed that it was on its way.
So what I want to do first of all is show that in the real world, a government deficit doesn't just create government debt. It also creates money that enables economic activity to occur, and that then changes the government debt ratio. But I want to start because the hard thing to get through to people's minds is that government spending in excess of taxation actually creates money. In fact, that's how fiat money is created. If you don't have a government that spends more than it gets back in taxation, you don't get fiat money created in the very first instance.
So, what I'm going to do here is use double-entry bookkeeping to show that if the government runs a deficit, rather than taking money away from the private sector, which is what the textbooks teach, it creates money for the private sector. So, we're going to start with deposits, which are a liability of the bank and they're an asset of non-banks, households, households, and firms. Uh, and now let's look at what taxation does. So if you have, if you're paying taxation, then what is happening is the government is taking tax dollars per year out of your deposit account. So I type "minus tax" here.
Now, what economists call "loanable funds" in our modern capitalist economy is fundamentally the money in your bank accounts. And what this is now showing is that the government spends more than it takes back in taxation. It increases the amount of money in private deposit accounts. So rather than a deficit taking money from the private sector, which is what the textbooks teach and what the government accountability office clearly believes, it actually creates money. So they've got that completely wrong, 100% wrong. They tell you that the government running a deficit will take money from the private sector. When you take a look at it, it actually adds money to the private sector. I haven't included government, uh, bond sales yet, but I'll do that, uh, as I go to the next stage.
What you now have when you put this together: the government creates money by running a deficit. Now, they then tell you, well, they've got to sell bonds as well, and the bond sales, they take money away from the private sector. If I run this model and I have no, uh, deficit at all. So, the government spends exactly what it gets back in taxation, then the system is sustainable. There's no GDP growth, but there's no debt occurring. There's no interest payments to make, and so on. But if the government spends just 1% of GDP more than it takes in taxation, ruin results because now you can see the government debt ratio rising exponentially. Interest payments also rising exponentially. There's been no change to GDP. Uh, so you get a higher and higher level of debt. So debt rises, GDP does not, and you end up in exactly the same crisis that those models put forward by the government accountability office argued are coming America's way unless it cuts its deficit and tries to repay private debt.
So I run this simulation for 80 years, and after 80 years here, you get a debt level similar to what the, um, the Office of Budget Responsibility is seeing coming out of the deficits that they're, that are currently happening. So this is the crisis that they expect to see come our way. And so when I simulate this model, I get the same result that the government accountability office is warning the Congress that America faces unless it eliminates its deficit. You can see the exponential shape of the government debt to GDP ratio. In my simulation, it's the same basic shape that the GAO is telling Congress to expect. Equally, interest payments, an exponential increase in interest payments.
Now, this is completely mistaken because what they're modeling is the government selling bonds to households. Now, they don't, you cannot buy in a primary auction. Only banks can get involved in primary auctions. Banks can sell those bonds later to households, and that does have a dramatic impact upon the economy. But it's not true that the textbook model is false. The bonds are sold in the first instance to the banks, which according to the government accounting validity office would lead to an inevitable crisis, uh, in the next 80 or so years in this simulation, with debt reaching 300% of GDP. Let's see what happens.
Notice first of all, GDP is rising. So the deficit is not just creating government debt. It is also creating money in people's bank accounts. That money turns over according to the velocity of money. So as well as getting an increasing level of debt, which is increasing the numerator in the government debt to GDP ratio, it's also increasing GDP. So what happens, as you can see now from the effect that's happening with the government debt ratio, it's not rising exponentially anymore. It's tapering. And the same thing for government interest payments. If I ran this for a number of more years, I would get to the point where the government debt ratio is 100% of GDP, and with the 5% interest on bonds, the interest payments would also stabilize at 5% of GDP.
Now, why is that? Let's go back and take a look what's going on here. Uh, all I've gone done is go from the, the myth that bonds and debt are owned by the households to saying the bonds and debt in the first instance are owned by the, uh, by the private banks. And what you get is that the deficit is increasing GDP at the same time as it's increasing the government debt ratio. And there is a relationship between the two because the numerator is adding the level of debt. The denominator is adding the deficit multiplied by the velocity of money. And that is what causes the ratio between government debt and GDP.
The government accountability office is focusing upon the increase in debt, does not understand that that deficit also creates money. And the deficit, because it's adding both to the numerator and the denominator, you get the increase in debt is equal to the deficit. The increase in GDP is equal to the deficit multiplied by the velocity of money. And therefore, the limit of the private government debt ratio is one over the velocity of money. So if you want to reduce the debt ratio, you need to increase the velocity of money.
The velocity of money has fallen dramatically since about 1990 because of the impact of high levels of private debt. Because going back to the '50s and '60s, households had relatively small levels of private debt. So they'd spend without really worrying about what that did to their level of private debt. Now, with the extremely high level of private debt we have after the last 30 years of deregulated finance, households are conscious that they've got to service their debt. So their response to having a high level of private debt is to spend more slowly on goods and services to reserve that money for paying interest payments. And what you find as a result of that is that the velocity of money has fallen dramatically as the level of private debt has risen.
So here is graphing private debt from 1945 forward, uh, and you can see that for quite some time, the velocity of money, the M2V here is dividing GDP by the, uh, M2, which is a measure of money in, fundamentally money in, in bank accounts, and finding that for the '50s and '60s and right up to the '80s, generally money turned over 1.8 times per year. It rose in the early '90s and peaked in about 1995, and it's been heading down ever since because this huge increase in private debt, predominantly after the '90s, was household debt. Households are now more conservative about the amount of spending they'll do. Velocity has plunged rather than money turning over 2.2 times per year. It fell down to 1.2 times per year. Uh, it's currently 1.4. That's far lower than it was in the '50s, '60s, and '70s. That's what's caused the government debt ratio to rise.
So if you want to reduce the government debt ratio, what you need to do is to reduce the level of private debt. And with less private debt, households will be not so worried about having to save, save money to pay the interest payments. So what would happen instead is you'd get a rising velocity of money, and that would reduce the government debt ratio. Now, that is completely different to what the government accountability office is recommending here. Their advice is wrong, and it's typical neoclassical mainstream advice. You should ignore it.
And this is the great tragedy. Politicians, just like academic economists, learn economics at university. They get one year, they cover the first-year stuff. Uh, they don't become completely, uh, addicted to neoclassical thought, but they're not even conscious of the extent to which the textbooks are in their head telling them what to do, and it's making mistakes because they're believing myths about how the economy operates. So ignore the GAO, ignore the Congressional Budget Office, ignore, uh, the Institute for Fiscal Studies, etc., etc. They all believe mainstream economics. They are all wrong. We need economists to understand money to advise the government of what to do. And they would tell them the exact opposite of what the GAO is saying. First of all, they would tell them, and that's what I'm saying now, that a deficit is necessary because unless you own a deficit, you don't create fiat money in the very first instance. And you also have to worry about the level of private debt. That's what causes economic crisis, not government debt.