CLASS UNITY  |  TRANSCRIPT

Steve Keen | The Global Financial Crisis of 2007–08

Class Unity recently spoke with economist Steve Keen about the causes of the 2007–08 global financial crisis, the private-debt dynamics behind his pre-crisis warnings, and why mainstream economics failed to anticipate the crash. Keen explains how bank-created credit contributes to aggregate demand, how rising leverage can produce an apparent Great Moderation before a crisis, and why debt deflation can leave an economy trapped in prolonged stagnation. He contrasts system-dynamics modeling with neoclassical equilibrium methods and discusses interest rates, inflation, Modern Monetary Theory, trade deficits, Brexit, debt jubilees, and the distributional power of finance. The later discussion turns to housing, policy responses, political obstacles, climate change, and the danger that financial valuations rest on unrealistic expectations about ecological stability. Readers can watch the original Class Unity video, read the related Class Unity teach-in post, and find Keen’s work on his Substack.

Class Unity: Hello, everyone, and welcome to another Class Unity speaker-series event. Class Unity is a Marxist organization that supports class-struggle politics in the United States. We believe in class politics, not identity politics. If you would like to support us, please consider donating or, even better, joining us; you can do either at classunity.org. Our political-education program promotes materialist analysis of politics, economics, and social issues. Part of that program is our current course on the 2008 financial crisis. The subprime-mortgage crisis of 2008 is the major economic event of the twenty-first century so far, and it continues to affect every dimension of political and economic life. Our purpose is to deepen our understanding of the crisis and the system of finance capitalism from which it emerged. These classes are open to members and nonmembers alike.

For the sixth week of our discussion group on the 2008 financial crisis, we will explore predictions made by economists in the years leading up to the crash. Joining us to discuss those predictions, as well as how his thinking developed over the following decade, is Professor Steve Keen. He is the author of Can We Avoid Another Financial Crisis?, Debunking Economics, and The New Economics: A Manifesto. He is a staunch critic of mainstream economics, an honorary professor at University College London, and a distinguished research fellow at the Institute for Strategy, Resilience and Security. You can find and support his work online. Professor Keen, thank you for speaking with us today. To start, could you introduce your 2006 article “The Recession We Can’t Avoid?” and explain what you saw happening in the years leading up to the 2008 crisis?

Steve Keen: That article is quite out of date in terms of my thinking now, but the broad principles are still correct. I heard you talking about Michael Hudson a short while ago. Michael and I have been close friends since we first met in the early 2000s. I remember meeting him in New York one day and taking him through my mathematical modeling in my hotel room. Michael is not mathematical, but his historical analysis is far better than mine. He asked me, “What is aggregate demand?” I answered, “GDP plus the change in debt,” and he said, “Why can’t other people see that?” Technically, my answer contained an error: aggregate demand is not GDP plus the change in debt, but turnover of existing money plus the change in debt. I have since proved that analytically. Still, that exchange reflected the perspective I had developed from Hyman Minsky’s financial-instability hypothesis.

The best book Minsky wrote is John Maynard Keynes. It is not a biography. He also wrote Stabilizing an Unstable Economy, which I do not recommend, but John Maynard Keynes is brilliant. There is also a shorter collection of essays, Can “It” Happen Again? Minsky writes extremely well in short articles, so that is where I would suggest starting.

I encountered Minsky while doing a master’s degree on my way to becoming an academic. We were assigned to read and review a book, and I chose John Maynard Keynes. By then I had read a great deal of Marx and Marxist political economy. Virtually all the critics of capitalism I had read emphasized a tendency toward stagnation, but that did not make sense to me because I saw a stronger tendency toward booms and busts. That was precisely Minsky’s orientation.

His basic idea was that capitalism moves from the depressed expectations that follow a crisis toward increasingly euphoric expectations as the period of stability lengthens and memories of the previous crisis fade. That throws the mainstream notion of rational expectations out the window: expectations change through historical time. Immediately after a crisis, both banks and borrowers remain conservative because of what they have just experienced. Only relatively conservative projects are put forward for debt-based funding. Because the economy is recovering, most of those projects succeed. Both lenders and borrowers then conclude that they were too cautious and that greater leverage would have made them more money. Rising leverage itself adds to aggregate demand, so a boom begins. That is where the idea that stability is destabilizing comes from.

Near the top of the cycle, increased economic activity strengthens the bargaining power of workers and suppliers of raw materials, particularly energy. That cuts into the profits capitalists expect. As the boom approaches its peak and realized profits fall short of expectations, investment slows and the economy falls back into a slump. That was my overall orientation.

For my doctorate, I built a mathematical model of this process. Minsky had tried to model it in his own doctoral thesis in 1957, but he chose the wrong foundation: a second-order difference-equation model associated with Hansen, Samuelson, and Hicks. I knew from the mathematics that it was a false model, so I looked for another foundation and chose Richard Goodwin’s growth-cycle model. I highly recommend adding Goodwin to your reading list. His 1967 paper “A Growth Cycle” was a centenary tribute to Karl Marx’s Capital, because the model formalized the cyclical argument Marx laid out in chapter 25 of volume I.

I added debt to Goodwin’s model and obtained Minsky’s financial-instability hypothesis, with a few twists that could not be derived from verbal reasoning alone. The model predicted declining cycles before the crisis, rather than ever larger booms and busts. I remember showing the graph to a conservative but very decent econometrician at the University of New South Wales. He looked at it and said, “Steve, if you have identified anything that exists in actual capitalism, we are in deep, deep trouble.” That was the trouble that arrived in 2007.

My focus on private debt shaped how I approached the crisis. I began writing the papers you read after being asked to serve as an expert witness in a case against a predatory lender. I had not looked at the aggregate debt figures for eight or ten years because I had been writing Debunking Economics and arguing with neoclassical economists over what they call economic theory. When I returned to the Australian data, I saw an exponential increase—not merely in private debt, but in the ratio of private debt to GDP. I thought that it could not continue and had to end in a crash. I then obtained the United States data from the Federal Reserve. The rise was not quite as extreme, but it showed the same pattern. I reasoned that the private-debt ratio could not keep rising forever; when it stopped, credit would cease adding to aggregate demand and begin subtracting from it, causing a crisis.

Somebody had to warn people, and I was probably that somebody in Australia.

I entered the blogosphere because there was no chance of getting a warning published in an academic journal quickly enough, given the time lags and the resistance I faced from the mainstream. I launched the blog almost immediately after looking at the data in December 2005. That is where the paper came from.

Class Unity: Thank you. What kind of response did you get at the time, especially from your peers?

Steve Keen: My peers generally derided me. I remember one neoclassical economist being asked about my views in a newspaper and replying, “Keen? A minority of one.” I wish I could find a copy. Their models of capitalism had no meaningful role for banks, debt, or money. Their model of banking, called loanable funds, treats banks as intermediaries. I call it the Ashley Madison theory of banking: the intermediary does not do the activity itself but arranges for two other people to do it and charges for the service. That is how neoclassical economics imagines banks.

Once you recognize that banks create money when they lend, and that credit therefore contributes to aggregate demand, you can see a crisis of this kind coming. Yet I was dismissed because, according to the standard story, banks merely transfer funds between savers and borrowers. I was used to abuse in the academic world, but I gained considerable traction in the media. I appeared on Australia’s leading national current-affairs program, the 7.30 Report. A normal broadcast had six five-minute segments; I received a fifteen-minute segment. The next day, the journalist who had interviewed me challenged the prime minister about my analysis, and a week later the government released a stimulus package.

Some elements made sense. Everyone who had paid tax that year received a thousand dollars, nominally as a tax rebate but effectively as a direct injection into the economy. There was also a major program to construct school buildings, halls, and gymnasiums, and to insulate houses. But the government also doubled and tripled grants for first-time home buyers. I was horrified because Australia had an even larger housing bubble than the United States. I asked, “Aren’t Australian house prices high enough for you yet?” In the end, reinflating the housing bubble was the main reason Australia avoided a severe crisis.

Unfortunately, I had made a bet with a right-wing mainstream economist working for a merchant bank about whether house prices would crash. The government put its support scheme in place after the bet, but journalists only wanted to know who won; they did not care about the argument. I lost the bet, lost much of my media exposure, and people said I had been wrong. But the reason Australia avoided a downturn was that government policy prevented credit from becoming negative. The United States experienced a substantial period of negative credit. I can show that with a graph, if you would like.

Class Unity: Yes, that would be great.

Steve Keen: Let me share my screen. This is American private debt going back to 1950. It began at roughly 100 percent of GDP, rose through the boom that ended with the 1987 stock-market crash, fell somewhat, and then climbed to about 170 percent of GDP. My argument was that this could not continue and that a reversal would produce an economic crash.

Credit is the rate of change of private debt. In the United States, it peaked at around 15 percent of GDP in 2006 and fell to minus 5 percent in 2010. That is a swing equal to 20 percent of GDP in credit-based demand, and it drove unemployment upward. If I restrict the graph to the period from about 1990 through 2015, the correlation between credit and unemployment is approximately minus 0.92. Ben Bernanke argued that credit should have no significant effect on aggregate demand because lending represents a pure redistribution. The data show the opposite. To this day, only one neoclassical economist has taken this question seriously. Most do not examine the evidence because it upsets their story about economic fluctuations. Private debt, banks, and money are absent from their macroeconomic models.

Australia displayed the same underlying dynamics, though the correlation was weaker because exports and government spending had a greater influence. Credit fell from about 25 percent of GDP to roughly 5 percent, but it did not become negative, which is why Australia avoided the worst of the crisis. Japan should have been the canary in the coal mine. Its bubble economy began in the 1980s and displayed essentially the same relationship over decades of data. This is screamingly obvious once you look at the figures. The only way to avoid being affected by it is not to look in the first place, and that is unfortunately what neoclassical economists do.

Class Unity: Thank you for sharing that. The inverse relationship in the graph is incredible. Let us open the discussion to questions. You said that aggregate demand consists of the turnover of existing money plus the change in debt. Could you explain those terms and the factors affecting the correlation shown in the graph?

Steve Keen: It is a causal relationship. To explain it, I developed what I call a Moore table, named for Basil Moore, the Canadian economist who developed the modern theory of endogenous money. Moore argued that banks do not transfer money from savers to borrowers, as neoclassical theory claims; they create money through lending. He developed the overall explanation but never fully worked out the macroeconomics. I was trying to explain why credit is part of aggregate demand, and even some post-Keynesian friends whom I greatly respect could not see it. I once asked one of them how people buy houses, and he answered, “Out of their savings.” I found that bizarre.

I had formally stated that aggregate demand equals GDP plus the change in debt. That claim was challenged in a debate in the Review of Keynesian Economics involving Marc Lavoie, Thomas Palley, Brett Fiebiger, and others. The challenge was straightforward: unless I could show that my argument was consistent with the accounting identity that expenditure equals income, I should rethink it. I agreed. If I could not demonstrate it under that identity, I was wrong.

The Moore table puts each sector’s expenditure across the rows and its income down the columns. Imagine dividing the economy into households, services, and manufacturing. Spending appears as a negative entry for the buyer and a positive entry for the seller. Each row sums to zero: the negative entry on the diagonal is expenditure, and the sum of the off-diagonal entries is income. Aggregate expenditure therefore equals aggregate income.

If you model the neoclassical idea that one sector lends to another, the loan is a transfer across accounts, not a purchase. The negative and positive credit entries cancel. If banks were merely intermediaries, neoclassical economists would be right that credit plays no role in aggregate demand. But when a bank makes a loan, the borrower’s debt rises on the asset side of the bank’s ledger while an equal amount of new money appears in the borrower’s deposit account. When that money is spent, there is no offsetting loss elsewhere. Credit becomes part of both aggregate demand and aggregate income. I have proved this mathematically by summing both the diagonal and off-diagonal elements of the matrix; credit appears in both.

Demand financed from the turnover of existing money may rise or fall, but it cannot be negative. Credit can become negative when people pay debt down. It can therefore add very large positive amounts during an upswing and equally important negative amounts during a downturn. This is the effect of bank money creation on aggregate demand, and the mainstream leaves it out.

Class Unity: That makes sense. Credit adds money to the pool available to households, so they are likely to spend it.

Steve Keen: Exactly. People do not borrow for the sheer pleasure of being in debt. Debt is no fun; I am speaking from painful personal experience arising from family circumstances. People borrow in order to spend, so the money created by bank lending enters aggregate demand dollar for dollar and then continues circulating through the system.

Class Unity: How do you understand the relationship between mathematical modeling in economics and qualitative approaches, including historical and behavioral analysis? What does a quantitative approach add to qualitative scholarship, and what are the limits of a purely modeling approach?

Steve Keen: I have always supported mathematical modeling. I criticize the way neoclassical economists use mathematics. In 1973, I led the student revolt at the University of Sydney against the teaching of mainstream economics, which led to the creation of a political-economy department in 1975. I had completed only one year of mathematics in my undergraduate degree, but it gave me a strong foundation. Neoclassical economists do not merely use mathematics; they abuse it. They make extraordinarily unrealistic assumptions to preserve their ideology because, whenever they attempt to provide a logical foundation for propositions such as supply and demand or consumer equilibrium, the mathematics violates their beliefs.

Consider the market demand curve. The Sonnenschein–Mantel–Debreu theorem shows that, although neoclassical assumptions can produce a downward-sloping demand curve for a single individual, they cannot establish one for a market. For an individual, one can make the simplifying assumption that a change in price will not change that individual’s income. But a national market contains millions of people. When the price of bananas changes, it changes the incomes of people who produce bananas as well as the behavior of people who buy them. Once income effects are included, the aggregate demand curve can have virtually any polynomial shape.

How did the mainstream respond? With ludicrous assumptions. Paul Samuelson wrote in a 1956 paper that we cannot derive general conclusions directly from individuals, but might treat families as units because “blood is thicker than water.” He then imagined redistributing income within a family until the ethical worth of each person’s marginal dollar was equal, and proposed extending the same operation to the national level. That is effectively an assumption of benevolent dictatorship in order to force a market demand curve to slope downward. The graduate textbook by Mas-Colell and his coauthors likewise refers to an ethically adjusted demand curve in which income might be redistributed by a benevolent central authority. To make their model of capitalism work, they must assume a socialist mechanism. It is ridiculous.

Good mathematical foundations are essential, but neoclassical microeconomics cannot provide them. Its market supply and demand curves are unsound. We need macroeconomic foundations built from definitions and realistic behavioral assumptions. In the last several years, I have realized that I can derive Goodwin’s growth cycle directly from the definitions of the employment ratio and the wage share of GDP. Adding the private-debt-to-GDP ratio generates a Minsky model, and adding the government-spending ratio generates a capitalist economy with government expenditure.

Let me show you a model in Ravel. These equations are derived from mathematical definitions: the employment rate is the number of workers divided by the population, and the wage share is wages divided by GDP. With simple behavioral assumptions, and with neither government nor debt in the system, the model produces cyclical behavior—the Goodwin growth cycle that formalizes Marx’s argument in chapter 25 of volume I of Capital. Add debt, and the model generates Minsky’s financial-instability hypothesis. The cycles continue while private debt rises. One emergent result is that rising private debt comes at the expense of workers’ wages, even though workers do no borrowing in this version of the model.

This is the model I had in mind when I warned about the approaching crisis. Notice that the cycles initially decline, making the system look as though it is approaching equilibrium. Run it longer, and the cycles begin to grow. Minsky spoke of stability becoming destabilizing, but imagined a single boom-and-bust cycle. Here a sequence of cycles compounds over time. In 1992, when I first constructed the model, it predicted a Great Moderation before the crisis. Neoclassical economists later celebrated the Great Moderation as proof of their excellent management. I saw the pattern my model had predicted appearing in the real data and found it terrifying. Mathematical modeling is essential, but do not concede it to neoclassical economics. Work from the top down, begin with macroeconomic definitions, and remain realistic.

Class Unity: Could you elaborate on the causes of Japan’s persistent lost decades? In a pre-crisis article, you described them as the result of classic debt deflation: Japan’s asset bubble collapsed at the end of the 1980s, yet the remaining debt burden made recovery impossible. Does that assessment still hold?

Steve Keen: Private debt remains the main problem, although it has fallen somewhat. Japan exhibits the same dynamic I showed for the United States, but across roughly fifty years of data. Rising private debt produced the boom; the bust occurred in 1990; and credit then plunged. Private debt peaked at approximately 225 percent of GDP in 1995 and has only fallen to around 160 percent. There has been no thorough restructuring of private debt comparable to what happened after the Great Depression.

In the United States, the Depression drove credit to roughly minus 10 percent of GDP and caused unemployment to surge. Government spending associated with the Second World War then helped reduce the private-debt ratio from around 130 percent of GDP to about 50 percent. The postwar recovery and capitalism’s Golden Age began from that low-debt position. That is what we should be trying to restore, which is why Michael Hudson and I support a debt jubilee. An oversized financial sector produces capitalism’s worst crises.

Japan has also sustained an enormous level of government spending. Government spending creates money in much the same way that private-bank lending does, and the central bank has bought large quantities of government bonds. Because Japan usually ran a trade surplus, this did not destroy its currency. This is one point on which I disagree with Modern Monetary Theory: the claim that a trade deficit is good is nonsense. A trade deficit drains money in the same way as a government surplus. Japan could keep buying its own government debt without undermining its currency because it maintained a trade surplus. But it has neither created enough government money nor reduced private debt sufficiently. It remains trapped partly because it continues to follow conventional economic thinking.

Class Unity: You have begun to address this, but could you expand on how your theory relates to Modern Monetary Theory and proposals such as minting the coin?

Steve Keen: Modern Monetary Theory is correct about government money creation. I was supposed to present a paper at an MMT conference in Leeds proving its core claim with my software, but I was disinvited, which did not impress me.

The Ravel model uses double-entry bookkeeping and handles the mathematics as well. It shows private-bank lending increasing both deposits and loans. It also shows government spending in excess of taxation creating deposits and reserves, with bond purchases financed by money created through the deficit itself. If government spending and taxation are each 30 percent of GDP, the budget is balanced. If the government decides to run a surplus, GDP falls. If it spends more than it takes back in taxes, it creates additional demand and enables the economy to function properly. The model directly demonstrates that MMT is right about domestic money creation.

Where I disagree is on trade and on a rather mechanical view of production that almost resurrects Say’s law. Some MMT economists have attached peculiar ideas to an accurate insight. Stephanie Kelton, Scott Fullwiler, and Warren Mosler have done very good work, but I disagree with several other leading figures. The sound core is that government spending creates money.

Class Unity: A model you showed earlier traced the debt ratio over time. It periodically flattened as the economy crashed, but over the longer run the line kept rising. How long can that continue, and does it imply a still larger crash in the future?

Steve Keen: I do not expect a larger financial crash of the same kind. The global financial crisis was the Great Depression of our time, but government was far larger than it had been before the 1930s. In the earlier period, government spending and taxation were each around 5 percent of GDP; now they are 30 percent or more. What conventional economists call automatic stabilizers, and Minsky called “big government,” mean that a downturn reduces tax receipts and increases welfare payments. Government spending thereby counteracts part of the decline. The collapse is less extreme than in the more purely credit-based capitalism that existed before the 1930s, but the underlying debt problem is not necessarily resolved.

Looking at the long-run history of American private and public debt, one can see the Panic of 1837, the crises of the 1870s, and the Great Depression. In each case, credit fell sharply and the private-debt ratio was eventually corrected. During the Great Depression and the Second World War, the ratio fell from around 140 percent of GDP to roughly 40 percent. That low debt burden, combined with rapid turnover of existing money, enabled capitalism’s Golden Age. Even after its recent decline, today’s private-debt ratio remains above the peak reached during the Great Depression. We have not reset the financial system, and credit-based demand consequently remains weak. Without a large rise in credit-driven demand, there cannot be an equally large fall. What is commonly called secular stagnation is really credit stagnation.

Class Unity: In your pre-crisis paper, you discussed whether the Reserve Bank of Australia should raise rates. Higher rates increase the interest burden and would seem to increase the risk of recession. Could you explain the relationship among interest rates, debt service, and recession?

Steve Keen: Banks are pulling something of a confidence trick by setting lending rates above government-bond rates. Most bankers probably do not realize that is what they are doing. Interest received on government bonds is income to a bank, not a funding cost, so the claim that banks must borrow at that rate and lend at a higher rate to preserve a margin is wrong. Warren Mosler makes this point as well. The true cost of money for a bank consists mainly of physical infrastructure, payment systems, and the limited work it does to assess creditworthiness.

Banks benefit from higher rates on existing government debt, but higher lending rates discourage new borrowing. In the United States, most mortgages have thirty-year fixed rates, so higher rates directly affect only new borrowers. The average existing borrower remains in the same financial position. In Australia and several other countries, almost all mortgages have floating rates. When the central bank raises its rate, private banks raise mortgage rates further, suppressing household demand as well as investment demand.

Interest rates dampen activity, but they are not a fine-tuning mechanism or an equilibrium price-setting system. Minsky makes this point very well in John Maynard Keynes. In a speculative or Ponzi boom, people will try to borrow regardless of the rate. An Australian Ponzi financier, Christopher Skase, illustrated the problem. He developed expensive real-estate projects that produced insufficient income but kept rising in market value. Because the income on his assets was lower than his debt-servicing costs, he desperately needed to keep borrowing. Lenders repeatedly raised the rate they offered him, but he could never say no; without the next loan, he would be insolvent.

He eventually made a three-billion-dollar takeover offer for MGM. A prominent American billionaire on MGM’s board examined the figures, recognized a Ponzi scheme, and persuaded the company to reject the offer. The following week, Skase went bankrupt because he could not meet a seventeen-million-dollar loan installment. Had the takeover succeeded, the new funds would have paid the installment and allowed the scheme to continue. That is the fragility produced by higher rates. Instead of smoothly adjusting the economy, rate policy creates a boom-and-crash pattern.

Paul Volcker’s policy in the late 1970s and early 1980s is another example. He believed he could fine-tune the demand for money according to Milton Friedman’s theory. Instead, he crushed the economy just as manufacturing in China was taking off. The resulting recession weakened unions and accelerated the loss of American manufacturing jobs. That is what brought inflation down. Trying to control an economy with interest rates is like trying to control a light switch by hitting it with a club.

Class Unity: Who does inflation hurt most?

Steve Keen: It hurts asset holders, although the distributional effects are not entirely straightforward. Blair Fix, whose work appears at Economics from the Top Down, has done brilliant multi-commodity analysis of the consumer price index. Instead of looking only at an average price, he studies the prices of many goods and who purchases them. His research shows that many recent price increases have hit working-class people harder than the wealthy. Isabella Weber has also shown that inflation was driven not by wages rising faster than prices, but by markups rising faster than inflation. That can benefit capitalists because it raises their margins. Pure asset holders nevertheless dislike inflation because it reduces the real value of their assets, which is why they complain so loudly and press for low inflation.

Class Unity: You also wrote that rising household debt transfers wealth from wage earners to financiers. If rates are raised to lower inflation and a recession follows, debtors go bankrupt and financiers can appropriate their assets. How do bankers, financiers, and asset holders ever come out worse off?

Steve Keen: The industrial sector is the part that gets crushed. One of my favorite passages in Marx describes financiers as the “roving cavaliers of credit.” Periodic booms and busts give this parasitic class the opportunity to take over industrial enterprises, even though financiers understand nothing about manufacturing and should have nothing to do with it.

Marx deliberately set aside many monetary and wage changes in volume I of Capital so that he could isolate the surplus-value mechanism. But in Theories of Surplus Value and volume III, he brought money back in. He asked what determines the price of money and suggested that it rests on expected future returns rather than on a cost of production. At today’s level of debt, the financial class dominates capitalism instead of the manufacturing class. Financiers do not make anything, do not understand production, and raise costs for manufacturers. If I must choose between an industrial capitalist and a financial capitalist, I will take the industrial capitalist any day. Reducing the scale of finance is one of the best things we could do.

Class Unity: In a 2013 paper, you wrote that one of Minsky’s guiding principles was that a model of capitalism must be capable of generating a depression as a possible outcome. You quoted him as saying that economic theory must make a Great Depression one of the possible states in which a capitalist economy can find itself. We can explain a phenomenon only if it is possible within the model we use; if the model rules it out, it assumes away the very thing that needs explaining. It seems that much of your disagreement with neoclassical economics—and perhaps with some post-Keynesian and MMT approaches—begins at the level of assumptions. What would you add to that?

There is a second question. The papers we read agreed that when scheduled debt payments exceed debtors’ ability to pay from income, a crisis follows. That sounds superficially similar to Thomas Piketty’s argument that r is greater than g. Many people had already identified the problem, yet Piketty’s version attracted enormous attention. What do you make of that comparison? I also have a question about trade deficits, but I can hold it until after these two.

Steve Keen: A model must be able to generate the phenomena it is intended to explain. The extraordinary problem with the neoclassical model is that, as Minsky said, it assumes away the interesting questions. It assumes equilibrium, omits the financial sector, and assumes harmony. In effect, it assumes a capitalism without class conflict, booms, or busts, so it cannot explain the system in which we actually live.

The mainstream response to the financial crisis was to add “financial frictions” to its models. But what is a friction? It is something that slows the return to equilibrium. Finance is not a friction; it is a banana peel. You slip on it and the process accelerates. The mainstream has the issue backward. I have spent too many years fighting economists who do not want to understand an alternative position or examine what actually happens. I have recently had the same experience trying to explain money creation to some Austrian and neoclassical economists. They simply do not read the criticisms.

I sometimes make a religious analogy, and it applies in Marxist circles as well as neoclassical ones. Inside the Vatican, you might debate whether Mary was twenty or twenty-one when she met Joseph, but you cannot say that the Virgin Birth did not happen. If an archaeologist claimed to have found the body of Jesus Christ, the institution would not calmly examine the research; it would reject the person as a threat. Intellectual paradigms behave similarly. Once a paradigm is embedded in your mind, you struggle to understand factors that the model cannot reproduce. That is a generic problem in every discipline.

Economics has an additional difficulty. Max Planck did not literally say that science advances one funeral at a time, but he did explain scientific progress as generational change. In physics, once an anomaly is discovered, it remains. Once the ether is abandoned or the black-body-radiation problem exposes the limits of Maxwell’s equations, the anomaly cannot be wished away. Older scholars may keep trying to fit it into the existing paradigm, but younger researchers eventually build careers by extending the new approach.

Economics lacks that mechanism for two reasons. First, its crises are transient and cannot be reproduced as controlled experiments. The profession never understood or explained the Great Depression, and eventually stopped talking about it. It expected a slump after the Second World War and got a boom; then came inflation in the 1960s and stagnation in the 1970s. The problems keep changing, so there is no permanent anomaly that can be rerun experimentally.

Second, the neoclassical vision of capitalism is ideological. It depicts capitalism as the best possible social system: a meritocracy in equilibrium, in which everyone is paid a marginal product, welfare is maximized, and power and exploitation do not exist. Zealous lecturers can always find a few students who accept this worldview. I criticized professors who taught an earlier version of it when I was twenty and they were sixty. Now I am seventy, and contemporaries of mine teach an even more extreme version. Generational change does not occur; the paradigm remains locked in.

The only way around that lock-in may be to enter from a different discipline. That is why I tell students not to study economics. Study system dynamics and then apply it to economics. System dynamics is fundamentally agnostic: it does not automatically produce equilibrium, but cycles and fluctuations. A different technology gives you a different outcome. That is the long answer to your first question. Remind me of the second.

Class Unity: Many people, including Michael Hudson, have said that when aggregate claims on income exceed the capacity to pay, a crisis follows. That sounds somewhat like Piketty’s formula r > g. Is that comparison right?

Steve Keen: Piketty is not a bad person. I met him online recently in a discussion organized by the David Graeber Institute. He was willing to step back, behave modestly, and respond reasonably to Michael Hudson, rather than being dogmatic. I gained respect for him from that experience. But r > g is a very static, equilibrium-based formulation.

A dynamic model generates cycles. My model contains the employment ratio, the wage share of GDP, and the private-debt ratio. Mathematically, this three-dimensional system has three equilibria. One contains negative quantities and can be ruled out. Of the other two, one has a finite wage share, employment rate, and debt ratio; the other has a zero wage share, zero employment, and an infinite debt ratio. Matheus Grasselli and Bernardo Costa Lima call these the good and bad equilibria.

At a low rate of interest or a low propensity to invest, the good equilibrium can be stable. A high propensity to invest—which sounds as though it should be desirable—a high interest rate, or some combination of the two can make it unstable. The good equilibrium becomes a strange attractor: from a distance, the system moves toward it, but once it gets close enough, the equilibrium’s mathematical properties push it toward the bad equilibrium. That dynamic is far more realistic as an account of capitalism than the static statement r > g.

Class Unity: One more question. You agree with MMT economists about many things but disagree with them about trade deficits. Michael Hudson’s Super Imperialism, as I understand it, argues that the United States imports more than it exports while other countries accumulate dollar surpluses. The United States sells little that those countries can buy with those dollars, apart from government bonds, so foreign exporters receive IOUs while the United States receives real goods. The dollars are recycled into bonds and help finance the American military system that polices the rest of the world. This sounds like an imperial free lunch, and it is a trade-deficit arrangement. Why, then, do you say trade deficits are bad?

Steve Keen: First, the sum of all trade deficits is zero. We are not trading with Mars yet. If one country runs a deficit, others must run an equivalent surplus. Warren Mosler’s Seven Deadly Innocent Frauds of Economic Policy is entirely American in its focus: “They give us goods; we give them pieces of paper.” If you want an American-centric position, that is fine. But as a general economic principle, the claim that deficits are good would require policies that constrain them, precisely because all deficits and surpluses must sum to zero. If an American deficit is good for the United States, the corresponding surplus must be bad for the rest of the world. A global approach would therefore need rules limiting imbalances. MMT offers none.

Second, MMT’s central insight is monetary: it explains how government money is created and why that matters. Yet when discussing trade, some MMT advocates suddenly say money is only pieces of paper and that the country receiving goods wins. That undercuts their own core argument.

Third, if trade deficits were genuinely good in the ordinary capitalist sense, deficit countries should grow faster than surplus countries. Yet the largest deficit and surplus countries—the United States and China—show the opposite pattern. Since the 1970s, American economic growth has averaged around 2 percent per year while China’s was closer to 10 percent. I expect that a broader statistical analysis would show that trade surpluses correlate with faster growth, apart from countries driven into poverty by being forced to export food or raw materials their own people need. Countries that used trade surpluses to build manufacturing, such as South Korea, China, Japan, and postwar Germany, achieved higher welfare, faster growth, and more sophisticated employment. The United States has instead developed a financialized economy, inadequate career prospects, and widespread dependence on welfare, while young people in China face a far stronger industrial career structure.

Climate change may soon make much of this argument irrelevant. If a country cannot produce essential goods domestically, it may simply be unable to obtain them during a crisis. The COVID-19 pandemic demonstrated the problem. Authorities in the United States, the United Kingdom, and much of Europe initially downplayed masks partly because those countries no longer manufactured enough of them. Production was concentrated in Asia, whose governments needed masks for their own populations. The policies were not driven solely by ideas, but by lost productive capacity. I had planned to say nothing about this dispute at the Leeds conference, but after being excluded because I disagreed, I intend to challenge the argument directly when I have time.

Class Unity: Thank you. We are approaching ninety minutes, so we will try to fit in a few final questions. Why did you support Brexit?

Steve Keen: Australia has a relatively good electoral system: voting is compulsory and preferential. Instead of marking a single candidate, voters rank candidates numerically. Sophisticated voters can support the parties they wish would win, knowing that their preferences will cascade toward the major party they ultimately favor. When I lived in Surry Hills in Sydney, I would rank minor parties first, then the Greens, the Labor Party, the Liberal Party, and finally a religious conservative party. It was a protest vote: I could ultimately choose Labor while making clear that I regarded both major parties as inadequate. A growing share of Australian votes now goes to independents and minor parties, including the “teal” independents.

That is the political system I was accustomed to. When I was living in the United Kingdom, all the polls predicted that Brexit would lose. I opposed the monetary architecture established by the Maastricht Treaty and wanted to cast a protest vote that would give the European Union a warning. I assumed a large Brexit vote, short of victory, would force the EU to improve. Then I woke up the next morning and discovered that it had won. David Cameron resigned, and a cascade of disasters followed. Had I been able to predict the future, I would not have got out of bed.

Class Unity: Before the final substantive question, a lighter one: bourbon or Scotch?

Steve Keen: I am drinking Drambuie. Hardly anyone drinks it anymore, but it has much more flavor than straight Scotch. My father called it the elixir of the gods. It was one of the few things we agreed on.

Class Unity: You spoke earlier about debt jubilees and Michael Hudson’s work. From the perspective of someone living in the southern United States, economic conditions seem to be deteriorating. Houses throughout my suburban neighborhood are going up for sale as the children of aging immigrant residents sell to wealthier newcomers and people from out of town. The global economy is visibly reshaping life at home, which makes the idea of a debt jubilee very attractive. In practical terms, how do we break the power of the financiers who are in charge?

Steve Keen: If I were not seventy, I might give you a more hopeful answer. I have spent fifty years watching the left lose these debates, fail to be taken seriously, and give way to neoliberalism. We are not going to succeed in bringing the financiers down. They are going to bring capitalism down themselves.

This connects to my work on climate change. The neoclassical economic literature on climate change is the worst work I have read in fifty years. It is staggeringly foolish. Some models effectively assume that a roof protects an economy from climate change. They use present-day cross-sectional relationships between regional temperature and GDP to predict the consequences of global warming. That trivializes the problem because temperature differences of twenty-five or thirty degrees already exist among inhabited regions, while projected changes in the global average look small by comparison. The inference is nonsense. It was published only because neoclassical economists refereed one another’s neoclassical assumptions.

We are heading toward climate catastrophe. Which state are you in?

Class Unity: Louisiana. We have already had some of the first climate refugees in the United States, including Native American communities displaced from the coast. We have lost an enormous amount of coastline—roughly the area of a small state—and the familiar “boot” shape of Louisiana is disappearing.

Steve Keen: That will happen on a much larger scale, and when it does, it will make a mockery of the numbers neoclassical economists have produced. One well-known survey asked neoclassical economists to estimate the effect of warming from around one and a half degrees in the near term to seven degrees over two centuries. Their consensus implied that seven degrees of warming would reduce future GDP by only about 20 percent relative to a world without climate change. Spread over time, that becomes a reduction of roughly one-tenth of a percentage point in annual economic growth.

Climate scientists, by contrast, warn that seven degrees of warming could make survival impossible for much of the mammalian world. I may be exaggerating at the margin, but the direction is clear. Economists have no adequate conception of the risk. The financial sector has accepted this nonsense because it trusts economists and assumes they know what they are doing.

As climate disasters intensify, finance will collapse not because of another ordinary bubble, but because its commitments can no longer be honored. Financial assets will be destroyed. Asset-market valuations will crash as it becomes obvious that physical assets are being damaged, insurance is unavailable, and large regions are becoming uninhabitable. That will include parts of the American South, where the cost of insured and uninsured damage will be gigantic. The system will come down, and the challenge will be to preserve something resembling civilization.

We are unlikely to remove the financiers before then, but they have helped lead us here. In the 1970s, the Apollo program became a victim of neoliberal influence over government policy: space exploration was dismissed as wasteful public spending. Had that investment continued, we might by now possess a lunar base, a Mars base, and the industrial engineering capacity needed to replace a large share of fossil-fuel energy with renewable or nuclear power. We might have had a potentially sustainable planet. We have very little chance of that now.

The system will therefore be brought down by the stupidity of economists, and finance will be among the first sectors destroyed because its valuations are based on mythical expectations about the economy’s ability to survive climate change.

Class Unity: Thank you. That is profoundly depressing.

Steve Keen: It is one reason I am drinking.

Class Unity: On that note, thank you very much for your time. This was an excellent talk, and the readings and answers were extremely valuable. It was a pleasure speaking with you.

Steve Keen: It was a pleasure speaking with you as well. Before I go, may I give a brief advertisement?

Class Unity: Of course.

Steve Keen: These days my work is supported by crowdfunding. At one stage I was earning about nine thousand dollars a month from it, which was enough to live on, but that has fallen to roughly five thousand. Starting a Substack has helped, but finances remain tight. If you want to support my work, you can subscribe there or through Patreon.

I also understand that relying on charitable people is difficult even when the people are generous, so I have built a software package called Ravel. The aim is to enter the business-intelligence market, generate revenue, and use part of it for socially progressive campaigns, including the effort to displace neoclassical economics. The images I showed today were produced with Ravel. Please consider looking at the software, following my Substack, or contributing through Patreon. Even a dollar a month or ten dollars a year helps. Otherwise, I am doing this on the smell of an oily rag, and at seventy-one it becomes tiring.

Class Unity: When we post the event on YouTube, we will include all those links in the description. Thank you again, Professor Keen. We hope to speak with you again sometime.

Steve Keen: Thank you. It was good fun. I look forward to seeing you again.