By Steve Keen
The stock market’s recent jitters have made many investors wonder whether there’s a new financial crisis just around the corner. Well, of course there isn’t — because we’ve never really left the last one.
Financial crises of the scale of the 2007 crash only really end when their causes are unwound by debt repayment, bankruptcies, debt write-offs, and inflation.
In the 1930s, there was plenty of all four. The end result was that US private debt fell by almost 100% of GDP from its deflation-spiked peak of 130% in 1933, to a
low of 35% at the end of WWII.
By comparison, the debt cutting we’ve been through so far in this crisis is trivial — a fall of under 20% from a far higher peak of 175% in 2010.
We’re attempting an economic revival from a debt level that exceeds the worst level reached during the 1930s.
And we thought this was going to work?
It has and will, of course, for a while. So long as we’re willing to borrow more than we repay, there will be growth. Rising debt means there is more money in the system, driving up the economy.
That has been happening since early 2010, when the deleveraging that caused the 2007 crisis stopped, and Americans began to borrow again.
But with private debt still at levels that make the late 1920s seem like a period of sobriety rather than Great Gatsby excess, the headroom to keep on borrowing simply isn’t there. So the economic revivals are likely to peter out much more rapidly than they did back in 1990, when debt peaked at “only” 120% of GDP.
Nowhere is this more evident than in that ultimate casino, Wall Street. There, margin debt has already returned to the peak it reached back in the biggest stock market bubble of all time, the DotCom bubble.
The increase then was stunning: having hardly ever exceeded half a percent of GDP before 1990, it rose fivefold to 2.75% of GDP in just 8 years. We hit that peak again in March 2014 — and we thought it could keep on rising?
Of course, we thought no such thing because, with the earnest assistance of conventional economic thinking, we convinced ourselves that leverage didn’t affect stock market prices and that instead prices reflect this ethereal thing called “fundamental value.”
To my eye, the real “fundamental value” is our willingness to go into debt to buy an asset.
That willingness rises as rising debt drives asset prices higher. But it also ultimately peters out, since the debt rises much more rapidly than the incomes that pay these debts off.
Then the Catch-22 of financial markets takes over: It takes not merely rising but accelerating debt to keep stock prices rising. Even a slowdown in the rate of acceleration of debt is enough to send the stock market south.
My acceleration indicator has been flagging that the stock market was due for a fall since mid-2013.
It’s a tribute to the power of the Fed’s Quantitative Easing that the market continued to defy the gravity of decelerating debt for so long. QE was really a
program to inflate asset prices since, as my colleague Michael Hudson puts it, “the Fed’s helicopter money fell on Wall Street, not Main Street”.
But with QE being unwound, the stock market is now back under the control of the not so tender mercies of excessive private debt.
So welcome to the New Crisis — same as the Old Crisis. The roller coaster ride is likely to continue.