Solving the Debt Crisis: An Ingenious Proposal

By CanSpeccy

Image source: Allen Roland's Blog

Australian economist Steve Keen proposes that instead of governments printing money and giving it to banks that lent money to folks who can't pay it back, they should print money and give it to the folks that can't pay back the money that banks lent -- on the condition that the recipients use the money to pay off their debts.

On the face of it, what Keen proposes is an alternative without a difference. Either way, the banks get back what they irresponsibly or incompetently lent to sub-prime borrowers who, by definition, were unlikely to pay it back. However, two important features distinguish Keen's idea from current mainstream economics thinking.

First, he says that not only should free money be given to debtors unable to repay their loans, but to everyone else too, which sounds fair, if inflationary.

Second, he says that when the banks get back the money they lent, they should not be allowed to lend it again. This seems a reasonable proposition, since the money lent was conjured by the banks out of thin air, so any right they had to lend it in the first place was by virtue of a government-granted license to print money, which evidently was employed irresponsibly, since much if not most of the money lent can't be paid back.

Then, argues Keen, once the unsustainable debt load has been reduced to a reasonable level, banks can be allowed to resume lending only to the extent required to support productive new investment in R and D, production facilities and other things that expand the real economy. This, says Keen, would bring to an end what he calls the Ponzi economy where people borrow to make speculative investments in assets they expect will rise in price because other people are borrowing to make speculative investments in assets they expect will rise in price.

Such restriction to bank activity would slash profits of the financial sector, from about 40% of all US corporate profits, currently, to perhaps five or six percent, which would seem entirely adequate for an industry that does little other than shuffle paper, or just digits, losing trillions in the process for which they expect the taxpayer to reimburse them.

In the course of such a contraction, Keen believes most banks would go broke and in that case, he indicates, their function should be taken over by the Government. That seems reasonable. Governments often manage to run things like railroads, highways, water works and post offices with tolerable efficiency, or at least not absolutely intolerable inefficiency.

Certainly, creating money out of nothing and lending it to people who might be able to pay it back looks like something governments could do at least as well as Northern Rock, Royal Bank of Scotland or any of the multitude of other banks that stupidly lost all the money they had, and even more that they didn't have, while paying their directors phenomenal salaries and bonuses.

The great merit of Steve Keen's scheme, so he maintains, is that it would end the second great depression now, rather than in a decade or two as will otherwise be the case. This claim, however, is not altogether convincing. The private sector cannot pay people more than their labor is worth. Yet minimum wages in the Western world are well above average salaries in China and other low-wage jurisdictions against which, under the GATT agreement, workers in the West must now compete without protection.

Furthermore, automation tends to reduce the global demand for labor. For example, Apple Corporation, embarrassed by a high suicide rate among workers employed by the Chinese contractor that manufacures the i-Pad, have decided to replace the workers with a million robots.

Thus it seems that more is required than Steve Keen's ingenious scheme to unwind the World's burden of debt if everyone who wishes to work has the opportunity to do so at a living wage. Moreover, in discussing his proposal with the BBC's Sarah Montague, Keen does not deal with the problem of unpayable sovereign debt, which is a major factor in the  current economic difficulties of many Western nations.

Nevertheless, the time is surely ripe for new ideas on how to assist homeowners, small business, and others burdened by intolerable debt to deleverage without intensifying the current recession or depression. Steve Keen is one of the few economists with a new idea worth considering.

And, insofar as it is inflationary, Keen's proposal for distributing government-created money would lower real wages, increase labor demand and so reduce unemployment. What's more, by distributing the cash equally to everyone, it would help redress the balance between the 1% and the 99.

See also:
Exporting the economy
The Economist Who Said "The Emperor Has No Clothes"