Contra Richard Koo and the Keynesians: It is not about ‘aggregate demand’ but about real prices

dollar notes falling from sky

Image by Salvatore Vuono

I do not want to waste your time and my energy with shooting down misguided Keynesian schemes all the time, schemes that have been refuted long ago and should by now be instantly laughed out of town whenever put forward. But arch-Keynesian Richard Koo’s latest attempt in the commentary section of the Financial Times to justify out-of-control deficit spending in the United States as a smartly designed and necessary policy that will keep ‘aggregate demand’ up and lead to recovery, is making the rounds on the internet. Koo’s article is a mechanical and naïve exposition of the 101 of Keynesian stimulus doctrine, clearly aimed at those who still perceive the economy as a simple equation with Y, C, I and lots of G in it. If private demand falls out from under the bottom of the economy, it can be replaced with the government’s demand. Simple.

And wrong, of course.

But the piece is not without some educational value. I promise this will be shorter than my attack on the new money mysticism at the IMF.

Fiscal suicide as recovery strategy

I am not sure if even in Washington there is anybody left who still seriously claims that $1trillion-plus deficits year-in and year-out are anything but a sure-fire sign of a public sector out of control – a public sector that despite generous and growing staffing levels is simply running out of fingers to put into the many holes from which the money is leaking. Yet Richard Koo wants us to believe there is a method to the recklessness, that this is a finely calibrated strategy to save the economy.

Koo’s story goes like this: The private sector has overdosed on credit in the preceding boom and is now in the process of balance sheet repair. Households and corporations are not borrowing, investing and spending but instead saving and paying down debt. This is sensible and unavoidable, and not even artificially low rates of zero percent can persuade them to change their ways and rather borrow and spend. This is where the government has to step in. It has to borrow the funds that corporations and households save and pay back to their original creditors, and spend these funds for the greater good so that ‘aggregate demand’ is kept from collapsing and the economy from tanking.

Here is Koo:

“[However,] if someone is saving money or paying down debt, someone else must be borrowing and spending that money to keep the economy going. In a normal world, it is the role of interest rates to ensure all saved funds are borrowed and spent, with interest rates rising when there are too many borrowers and falling when there are too few. But when the private sector as a whole is saving money or paying down debt at zero interest rates, the banks cannot lend the repaid debt or newly deposited savings because interest rates cannot go any lower. This means that, if left unattended, the economy will continuously lose aggregate demand equivalent to the unborrowed savings.”

 This is evidently wrong. This view neglects the function of market prices (other than interest rates) and the role of money – two aspects that Keynesians have a habit of ignoring. Let us go through this step by step.

 Restating Koo’s scenario to include money-flows and money-balances

 If some (or even a considerable number of) corporations and households use their present money balances or present money-income to repay debt, this simply means that rather than holding large money balances themselves or spending their current money-income on investment goods or consumption goods, this money now flows to the creditors of these households and corporations, and these creditors now either hold themselves larger money balances, or they re-invest in investment goods (productive assets, equities or bonds), or buy consumption goods. Only three options are logically available to anybody who receives a money-income: keep it in money, spend it on investment goods or consume it (spend it on consumption goods).

 The problem that Koo describes – a drop in ‘aggregate demand’ – can only materialize if the money-income that households and corporations received and previously ‘spent’ again on investment goods or consumption goods (and which thus kept circulating through the economy and maintained ‘aggregate demand‘), is now no longer spent on investment goods or on consumption goods because the creditors who now hold this extra money simply keep it in the form of higher cash balances. If the creditors spent the money that is being repaid to them again on investment or consumption goods, there would be no drop in ‘aggregate demand’ – and to the extent that the creditors lent the funds again to other private-sector borrowers there would, of course, be no net-deleveraging of the private sector in aggregate. Only if the creditors decide to keep accumulating money balances rather than channelling the money income again into consumption and investment will ‘aggregate demand’ drop.

 Of course, Koo will maintain that this is very likely indeed. Interest rates are zero, so the incentive to lend the money again is low. Additionally, nobody wants to borrow. So the creditors – and this must include banks, pension funds, insurance companies, in short anybody who has previously extended credit to households and corporations and now gets repaid – will likely keep hoarding money. And Koo would maintain that interest rates cannot fall any further – they are already at zero – so the extra money will not lead to lower rates and thus encourage extra borrowing.

 We can now rephrase Koo’s problem. What happens ‘in aggregate’ is simply this: economic actors reduce their money-outlays on non-money goods (investment and consumption goods) and instead accumulate money balances. But this must mean that, all else being equal, money-prices for non-money goods decline. The prices of consumption and investment goods fall and the purchasing power of money rises. This is deflation and is dreaded like the plague by the Keynesians, but wrongly so, as it is very clear that falling prices are exactly what will ultimately stop the ‘hoarding of money’ and encourage spending again – spending on consumption goods and investment goods.

 There is no way around the fact that a money-hoarding public considers the money-prices of non-money goods too high, which is precisely why the public keeps its wealth in money, and that it is falling prices that would rectify the situation easily. As the opportunity costs for holding wealth in the form of money rise with falling prices, the incentive to spend the money grows.

 Koo ignores falling prices as an essential corrective

 Koo only considers interest rates as a mechanism for keeping the economy in balance. He does not consider the role of other market prices. Interest rates are indeed important market prices (so important, in fact, that the central bank should not distort them, and distorting interest rates systematically – almost always to the downside – is indeed every central bank’s mission). Interest rates are relative prices. To be precise, they are the price differential between goods of the same kind at various points in time. But there are other important relative prices to consider, including those between different goods at the same time.

 If I consider the current price of a good – whether consumption or investment good – to be too high (to be unsustainably high) I will not spent my current money balances on this good, and, importantly, I may not borrow money – not even at zero percent – to buy it. The cost of borrowing is an important factor in my decision but it is just one factor. I could borrow the money for free and acquire the good but I would still encounter the risk of a price drop in whatever I buy with the borrowed money, and it is evidently that risk that is keeping people in cash at present. If I expect the price to drop in the future it would be better to not buy now, even if funding costs are near zero. (As an aside funding costs are hardly zero for most of us at present, as Koo implies, but this is not important for the argument.)

 As we have seen, Koo’s scenario of a drop in ‘aggregate demand’ is only feasible if the desire to hold wealth in the form of money rather than consumption goods and investment goods is high. People rather accumulate cash than spend it on investment goods or consumption goods. At present prices, they prefer money to goods and services.

 But hoarding money is a self-correcting process if (and that is a very big ‘if’ in our complete fiat money system) you allow prices to fall. At falling prices the opportunity cost of staying in cash –which gives you great flexibility but does not fulfil any consumption needs and gives you very meagre returns (just the rate of deflation) – rises constantly. (To assume that nobody will spend money in a deflationary environment is nonsense. It ignores ‘time preference’, which is essential to human action and which also explains why interest is a universal concept. To want something means, all else being equal, wanting it sooner rather than later. Current example: Prices of computers and smartphones are falling constantly yet people spend heavily on these items.)

 Consider this example of an imaginary entrepreneur

 An entrepreneur considers buying investment good X, which would help him realize a certain investment project. The current market price for X is P, and at this price the investment good promises to provide an internal rate of return of p. In Koo’s scenario there are plenty of savings around. So many in fact, that interest rates are zero. The entrepreneur could borrow for free, acquire X and obtain return p. Why does he not do it? Is his decision exclusively driven by the level of interest rates? Obviously not. He may not buy X because he considers P too high and consequently the return p too low. The investment good is too expensive. The low return of p does not compensate for all the risks still inherent in the overall investment project that X would help the entrepreneur realize. If the price P were lower and consequently the rate of return p higher, then the entrepreneur would invest.

 On the surface it may look attractive to buy an equity portfolio on credit if the loan rate is 1 percent and the dividend yield 3 percent. But you would still not do it if you fear that the equity market is about to drop by 20 percent.

 There is no escaping the fact that if people prefer holding money to buying non-money goods they consider the prices of non-money goods too expensive at current prices relative to the monetary asset. In short, money-prices are too high. This is hardly surprising after the extended monetary expansion that has caused the over-indebtedness of corporations and households in the first place. After an inflationary boom prices are too high and balance sheets overstretched. Importantly, the inflationary boom will not have lifted all prices to the same extent. Relative prices are also distorted.

 At the point of crisis, nobody borrows, everybody tries to repay debt (or defaults). The creditors accumulate extra cash balances, partly out of out of concern for the future and partly for lack of investment opportunities. The inflationary boom turns into a deflationary correction. Falling prices are now an essential ingredient for stabilizing the economy. (Again, just as the inflation has not lifted all prices by the same extent, the deflation will not depress all prices by the same extent. Relative prices will now re-adjust.) At lower prices, the desire to hoard money will subside and demand for investment and consumption goods will resurface. Those who did not participate in the boom but kept their savings and their credit standing intact and thus their ability to borrow and spend, are now faced with low interest rates and falling prices. The incentives to put money and credit to work are substantial. This group will play a crucial role in the recovery. Absolutely no state intervention is needed.

 What I just described is simply the market at work. Why does this not happen today? Because we live in fiat money system, in a system of fully elastic money, in which central banks keep printing money to stop its purchasing power from ever rising and prices from ever declining. Bizarrely, the central bankers seem to believe they are doing all of us a great favour. “Look,” they seem to say, “five years into the crisis and prices are not falling! Hooray, no deflation!” – Yes, and that is precisely the problem.

 A personal example

 We have lived in London for 16 years and for quite some time I felt that we could do with a larger apartment or house, given the size of our family. For years we have been potential buyers of real estate in London. During the tail end of the recent cheap-money-fuelled housing boom, we remained on the sidelines. After the bubble burst you might think that this was now a good opportunity to get into the market. But thanks to zero-interest rates from the Bank of England, various bank bailouts, quantitative easing, and other ‘stimulus’ measures, prices have not been falling in many parts of London, or not by much. Fact is, these policies have kept house prices in many parts of the country at artificially high levels in my view. In any case, these policies have certainly not ‘stimulated’ me into putting my own money to work. Lower prices might have done so – as might have any perception that the bubble had clearly dissolved, that the market had been allowed to liquidate what was unsustainable, and that present prices were now ‘real’ uninhibited market prices. Of course, none of this is the case due to highly interventionist policies. In the meantime, all the advocates of aggressive monetary stimulus are high-fiving themselves for having (so far at least) avoided deflation, having protected the housing market (which means protecting those who borrowed recklessly in the boom), and saved the banks.

 Current monetary policy is prohibiting the liquidation of imbalances, the correction of prices, the reallocation of resources, the rebalancing of the economy, and the reinvestment of repaid debt. Monetary policy is not aiding the recovery, it is obstructing the recovery. What monetary policy evidently tries to achieve is to create an illusion of recovery and stability. But nobody in their right mind trusts these prices.

 That such a deflationary correction as a free market would instigate would go on forever, that “the economy will continuously lose aggregate demand equivalent to the unborrowed savings”, as Koo claims, is simply nonsense. In an uninhibited market this is impossible.

 Stimulating demand – with higher prices!

 But our monetary masters have even crazier ideas. Not only is any drop in prices and any rise in money’s purchasing power to be prevented at all cost, prices need to keep rising and this – according to the logic of our central bank bureaucrats – will then stimulate the economy. Because all of us are so gullible that we will simply take the phenomenon of even further rises in nominal prices as an indication that things are fine and that we need to spend again.

 Here is Ben Bernanke, America’s Printmaster-in-Chief, almost exactly 2 years ago, explaining to the American public why rising prices of financial assets as a result of the Fed’s policy of ‘quantitative easing’ will help them. I quoted this already on numerous occasions. Apologies for doing so again but this is such a wonderful exposition of modern money madness that I keep going back to it. Apologies to Mr. Bernanke for throwing in some of my own comments.

“This approach (‘quantitative easing’, DS) eased financial conditions in the past and, so far, looks to be effective again (he said this two years ago, DS). Stock prices rose and long-term interest rates fell (bond prices rose, too. DS) when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance (but not lead to housing investment if house prices are still too high and still obviously distorted. DS). Lower corporate bond rates (higher bond prices) will encourage investment (well, not in bonds, and it won’t cause corporations to invest, as Richard Koo and I explained above. But here comes the real gem:). And higher stock prices will boost consumer wealth (sic!) and help increase confidence, which can also spur spending. (Emphasis mine, DS.) Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion. (Good luck, Ben. DS)”

 So, my imaginary entrepreneur is supposed to be encouraged to invest in X not by a drop in its price but by further rises in its price! And I am supposed to go home to my wife and say, “The crisis is evidently over. Home prices are going up! Come think of it, those London home prices will never fall. They can only ever go up! Let’s take our savings, take out a mortgage and buy now before the Bank of England makes them even more expensive!”

 The state makes a mess of monetary policy – than compounds it with fiscal policy

 Back to Richard Koo. The problem he describes will never occur in a free market. In fact, in a free market with hard money at its core, it is incredibly unlikely that the type of imbalances that were the starting point of Koo’s analysis could arise at all. To have large sections of the economy feel dangerously and hopelessly over-indebted requires the type of extended credit boom that can only occur in an elastic monetary system with central banks that can artificially cheapen credit for long stretches of time. The verdict on our monetary system is devastating: Central banks have actively encouraged an extended boom in lending and borrowing that has left prices inflated and distorted, and has left balance sheets overstretched. Now that the boom is over, even easier monetary policy from the very same central banks is hindering the dissolution of the distortions and a return to balance.

 But is this mess – created by the state with its mishandling of its money monopoly – now a justification, as Koo claims, for further state action, now in the form of deficit-spending? Certainly not.

 The whole concept of ‘aggregate demand’ assumes that for the functioning of the economy it does not matter whether demand originates from the private sector or from the state. It all just adds up to ‘aggregate demand’, to the statistical whole of GDP. But this is way too simplistic and mechanical. The economy is not a bucket filled with aggregate demand, and when some ‘demand’ spills out, we can fill up the bucket again with some other ‘demand’. ‘Demand’ is only ever a homogenous item in the parallel universe of macroeconomic statistics. A market economy is all about specific demand, about the specific use of scarce resources. We are all participating in this market economy and in the extended network of human cooperation that only the market economy allows, because each of us has specific goals and objectives. And if markets are not allowed to operate freely and prices are not allowed to adjust freely, the resulting distortions are a hindrance to our attempt to pursue our specific goals.

 Whenever government spending is high, it means that the market’s allocation of resources and the private use of resources are replaced with bureaucratic allocation of resources and the state’s use of resources. The grave distortions that are already the result of the state’s manipulation of money prices and interest rates are further compounded by an administrative rather than market-driven allocation of scarce means through fiscal policy.

 And is it really feasible that the state would simply discontinue whatever it started in the crisis to artificially prop up the GDP statistics once the private sector regained its footing? Would Koo suggest that the state makes redundant the people it hired during the times of deficit spending?

 Only solution: a return to markets

 Keynesians do not trust the market. Allowing prices to correct, so they claim, would cause never-ending deflationary spirals. This is without any basis in fact. It is rather their policy of fighting market imbalances with more intervention and more imbalances that will move the economy progressively further away from balance and true recovery. Keynesian policies will keep us in a constant loop of distorted markets and growing imbalances. They guarantee us a Groundhog Day of economic depression. Until, of course, patience runs out and the monetary and fiscal overkill – to now stimulate the economy ‘properly’ – is being applied and disaster ensues.

 Japan has followed the Keynesian rule-book fairly faithfully without ever shaking off its post-bubble problems. To the contrary, the country’s imbalances get scarier by the day, requiring some brutal catharsis in the not too distant future. Ironically, Richard Koo is an alleged authority on Japan, yet he prescribes the same or similar policies to the US today.

 Only a return to free and uninhibited markets, real prices and interest rates, and a return to hard money, can get us out of this mess.

 In the meantime, the debasement of paper money continues.



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Note to readers: Detlev speaking at the City Book Fair, London
Detlev interviewed by The Daily Bell and Germany's FINANCE-TV


  1. Chase says


    Another great piece. I am always shocked when Keynesians point to Japan in favor of their positions. I know it is very difficult to speculate but do you think Europe, Japan, or the U.S. will be the first bug to find a windshield? Or will it be more simultaneous than most think? It is a bizarre feeling to see the Keynesian endgame coming and having to know the horrors it brings with it.

    In Liberty, Chase

  2. nobbynobbs says

    Are you fcuking nuts, money that is repaid to creditors gets destroyed. All money is debt. When you borrow the bank creates money when you pay it back its destroyed unless someone else borrows. That’s what QE is about, trying to replace the money supply that is being destroyed

    • Myno says

      “All money is debt.” Money is something of value, and debt is an obligation to pay. So you’re claiming that “All value is an obligation to pay.” Governments actively promote that premise, demanding that to own is to owe (taxes). Sadly, many people actually believe that nonsense, and most of them vote to continue the madness. QE is just another tool to achieve it.

    • Aodhan says


      Extremes aside, any amount of commodity money or commodity-backed money suffices as a medium of exchange, because the market will alter naturally the quantity of it intermediating between two goods or services.

      That is, creating or destroying money doesn’t make a difference as long as is apparent to all money-users. For example, if you somehow “destroyed” 9/10s of all the money in existence tomorrow, and everyone knew that you would, what would happen to prices? A zero would be removed or a decimal point displaced. Then everything would go on like as before. Nothing has happened to wealth, only to the terms in which it is expressed.

      So, getting all hot and bothered about money being destroyed is unnecessary. It is being a monetary drama queen. It is confusing the representation of economic reality with economic reality. Money, as a medium of exchange, simply cannot be consumed, like other goods.

      Sound money is also not credit/debt. Here is the difference.

      Sound money is a certificate. It says “I have already produced. So can I have that now?”. It’s relatively safe to exchange goods and services for sound money, as the wealth has certainly been produced in the past.

      Credit/debt is a promise. It says “I will produce in future. So can I have that now?” It’s less safe to exchange goods and services for credit and create a debt, because the wealth may not be produced in the future.

      Now, if money starts getting counterfeited on a a wide scale, courtesy of QE junkies, but it’s not clear who is getting it first–so it’s not clear if there is money in the system for which production has already occurred, or credit in the system for which future production will be required, because they two are getting conflated by being represented by the identical tickets–then it stands to reason that economic decision-making is going to be perturbed.

      There will be more tickets to wealth than there is actual wealth. People will be led assume on the basis of those debased tickets that the wealth actually exists when it remains to be created.

      Now this fiction–lie, feint, deception–cannot go on forever: it will be eventually found out. Economic reality will ressert itself in the long-term. At some point, in some exchanges, the shortfall in actual wealth must be discovered, and someone must be out of pocket. Who can it be otherwise? The replacement of sound with unsound money–the attempted homogenization of sound money and outstanding credit in a currency blender–is a recipe for making people generally consume more now than later more than they really want to, and therefore making them poorer. Boom will inevitably turn to bust.

      Roughly, this happens either by inducing consumers to buy more secondary stuff now, because they think that they will still be able to buy more primary stuff later, when they really won’t have; and by inducing entrepreneurs to use up resources in investments that will eventually go sour, misled by interest rates on the loan market suggesting that the savings to support them are widely available, when they really aren’t available.

      Ultimately, unsound money is just people in charge telling lies about wealth to enrich themselves and their cronies, and rationalizing it as a selfless service to the masses courtesy of Keynesianism.

  3. Jamie says

    But if banks are creating money when they make loans, then aren’t they are destroying money when those loans are repaid? They extinguish an asset and a liability. So there will be less money out there in total to be spent as a result of the loan repayment?
    Also, total us public sector workers have significantly reduced over the past 4 years, so there is not growing staffing levels.

    • says

      Jamie, you make a good point there. It is similar to nobbynobs’ point, although I would put it differently: Not all the money that gets repaid gets “destroyed”. The interest that is being repaid is income for the banks and this money will be used to pay the bank’s expenses and profits to its shareholders. This part of the money keeps circulating. But your point is essentially correct. My “money-flow analysis” at the beginning of the blog assumes fully inelastic money, such as in a 100-percent gold standard – or a system in which there are no banks (or at least no fractional reserve banks) but only pension funds, investment funds and insurance companies, i.e. pure intermediaries that do not create ‘money’. This is of course a huge simplification, and it may seem strange in a blog by someone who talks about the problems with elastic money all the time. But please remember that I am addressing a specific position here. I simply wanted to show that Koo’s idea that the desire of the private sector to reduce its overall indebtedness must lead to ongoing economic contraction if not offset by the government is untenable. In an entirely free market – a market in which prices form freely and there is no fiscal policy – prices will ultimately stop the correction. A continuous deterioration of the economy is implausible. I wanted to take Koo’s starting point – the private sector wants to reduce debt – and in a ‘ceteris paribus’ analysis show how a free market would deal with this. For this purpose I disregarded the elasticity of the money supply in a first step. Only later do I consider – at least in some respect – the implications of a fully elastic system such as ours today. But I do not think that this changes the conclusion one bit. In a hard-money system the desire to reduce debt must lead to an instant rise in the purchasing power of gold, that is, a drop in the money-prices for non-money goods, or deflation. This is the process by which the economy deals with the changes in debt levels and finds a new balance. In an elastic money system, the desire to reduce debt leads also to a shrinkage in bank balance sheets as previously created deposit money gets destroyed. Again, the purchasing power of the remaining fiat money balances goes up, that is, the economy experiences deflation. And again this is part of the rebalancing of the economy. During the money-induced boom certain prices rise, debt levels go up, banks expand. In the following correction, debt levels go down, banks shrink and prices fall. If this sounds messy, it is. That is why my position (and that of all Austrian School economists) has been to argue for hard money, such as gold, as that would reduce the risk of a money-induced bank-lending boom in the first place. But once you had the artificial boom there is no alternative to going through the correction. I find it absurd that Koo and the other Keynesians (and many Monetarists) seem to argue that once we have a certain level of debt and a certain price level and once banks have created a certain amount of deposit money, the government and the central bank must now stop all these variables from ever correcting. In this instance, I particularly objected to the notion – put forward by Koo – that the private sector’s desire to de-leverage is in itself a problem for the economy with which the economy cannot deal without support from the state. Nobbynobs is correct that QE was partially conducted to stop deposit-money destruction but that still means that QE is obstructing the economy’s ‘natural’ rebalancing process.
      On public sector staffing: I was sloppy here. I should not have called it ‘public sector’ but ‘federal government’. Public sector employment has been declining in the US for years but employment in the Federal government has been exploding during the last Bush year and throughout the first Obama term. The federal payroll peaked last September. And it is of course the federal government that runs these policies and $1trillion-plus deficits. See this link:

  4. Jamie says

    Sorry one other question. You say price levels will adjust downwards if demand reduces, but what are your thoughts on wage levels? Do you think they can easily reduce? If not then it makes it difficult for price levels to drop, or just causes unemployment doesn’t it.

  5. Dirtt says

    Detlev. One could spend countless days and nights researching and reading about the credit bust and subsequent government shenanigans. Or one could read this one perfectly constructed analysis and sit on the beach and wait for what we are all waiting for: short bonds.

    It’s been a long wait. Could still be a longer wait. There are opportunities right now. But none include plans to hire. ZIRP and Obamacare are the two biggest sucker punches in my lifetime; maybe ever.

    Over 200 years ago people would hang for this biblical failure of human kind.

  6. Myno says

    I greatly appreciate your personal story about real estate. It clarified the situation marvelously.

    In the Fiat Economy (over here, the Obama Economy), it is a significant challenge to determine what makes a worthy investment (aside from gold, which nevertheless has its own risks). It is a measure of how confounding the Fiat Economy is, that people are willing to hold cash, when actual (not to mention likely future) inflation is a fact of life. Of course, with the threat of economic turmoil, even rampant money printing cannot guarantee steady inflation. As you pointed out, that expensive house for which you sign on the dotted line, could become a dead albatross around your neck, if a crisis ensues and the currency falters.

  7. Dr James Thompson says

    I think the central problem with the concept of “aggregate demand” is that it implies that demand must be at the very least monitored, and preferably managed in some way so that it can be maintained at a “healthy” level. This puts the cart before the horse. The only reason to work is to meet a particular set of personal demands. For example, Detlev, you could return to work in financial services, give up your evenings with your family, and buy a larger London house, and thus boost aggregate demand. However, you have chosen to spend your most precious asset, your time, in a different way.

    As a general rule, if you do not have a personal demand you do not need to exert yourself. Aggregate demand only needs to be maintained if work and economic activity are considered to be intrinsically good. Those who sing the praises of activity for activity’s sake seem to have the underlying fear that the devil will make work for idle hands. The proletariat must be kept busy. This is nonsense. A large section of the population regard work as something they do simply to meet their minimum demands, and they satisfy their remaining needs by social interaction, hobbies and so on which have peripheral impact on the economy.

    For the record, I do not want anyone to force me into economic activity against my will. Like you, I find many prices too high. I won’t even replace the windows in our house because the prices are too high. If they were to drop, I would get the work done. I will not be stampeded by even higher prices. I will spend my savings when I choose to, and not before.

    I suppose Krugman would label me a “cash hoarder”. I am simply a free citizen wishing only to buy things when I need them, and when I think the price is reasonable.

    • Jamie says

      Obviously the over 50% of unemployed youth in Spain and Greece want to be jobless then?! They just don’t want to be “forced into employment”. I’m sure they prefer to be poor rather than “forced into economic activity”. They don’t need to work because their “personal demands” are met by poverty.

  8. trent says

    Ok, lets stop dressing this up in economics, everything you say is true, but none of it matters. That’s right none of it, they don’t want prices to fall because they are insolvent, and the only thing that keeps them in POWER is the illusion of solvency. We will never have change or growth until power shifts from those that screwed things up to those that were prudent. ITS ALL ABOUT POWER, lets just call it what it is.

  9. macduggie says

    Couple of questions and a rubbish suggestion.

    It is theoretically possible for an economy to be so heavily indebted that any attempts by individual households and firms to deleverage will not in the aggregate be successful as falling returns lead to bankruptcies and unemployment, yes?

    Is it sensible to assume that the prices of non-discretionary goods will fall during a phase of contraction, with or without government intervention?

    And in “But is this mess – created by the state with its mishandling of its money monopoly..” the term “state” is unfortunate imo, there must be a term available that avoids endless and needless misunderstandings over your view on banks’ role in money creation. Status quo is the best alternative I can think of, and I’m aware it isn’t very good.

  10. says

    Question: If, in an honest economy, m’/m = i_h -> r (Money supply growth rate equals interest accrual, which is limited by real growth rate)


    in a socialist economy m’/m = i_s + g -> r


    i_s < i_h for equivalent real growth, or, in other words, socialism depresses investment, meaning that real growth will decline from investment starvation?

    The Keynesians believe the opposite.

  11. Rose says

    Detlev, at some point, could you please explain George Osborne’s latest move (i.e. transferring the alleged profits of the Bank of England from QE to the Treasury) and the potential short and long-term consequences.

  12. mikal13 says

    One question for you, Mr Schlichter, and this is something I don’t understand yet; after money has been printed into existence, are that money destroyed, like being wiped out of existence during the deflation, or do that money still exist somewhere in a different bankaccount but doesn’t change hands as often? I understand that when going back to the bank the money is out of circulation, but how can it be destroyed? Does destroyed mean abandonded as a currency of purchasing power, or destroyed like setting fire to a pile of paper…..I’m puzzled here…

    ON AGGREGATE DEAMND: As a nurse working in intensive care in Norway, I have come to the conclusion that society always progress forward, so that in our present system of socialdemocracy and it’s practical implementation the welfare state we have what Mises called socialism under dynamic conditions. Sick people that would have died before retirement goes into that retirement because they are saved and by that fact alone, continue consumption, thereby increasing the public expence. They are saved simply because medicine found a cure that wasn’t available fifty years ago. That changes deamand and demography. Which means that you have an ever expanding public aggregate demand that simply cannot be funded. In my opinion the QE’s aim to fund the public sector with false money because the people depending on government don’t bring their alcohol to the party, they must receive from someone else if they are going to drink. That is why we have inflation, to sustain the government revenue, I totaly agree with you that the economy could simply lower it’s prices and trade would function with less money in circulation. It’s the government that cannot pay the bill in deflation. Trade could still function. I know debt can’t be fully repaid, but let the lenders go bankrupt. The Keynsians are the economic excuse for socialdemocracy. woodoo economics.

    • George Thompson says

      I’m certainly the least qualified here to be answering your question, but it seems to me that most of the folding money or coinage existing today is insufficient for the huge amounts of debt most central governments have incurred. The vast bulk of money exists only in digital form. If you use a spreadsheet, simply enter a 1 followed by a number of zeroes, as many as you please, into any properly formatted cell. Now edit that cell by either removing or adding as many zeroes as you please. This is not unlike simply writing 1,000,000 on a piece of paper in pencil, then using an eraser changing it to 1,000. When the market crashed in 2007, that’s how my retirement savings were reduced by almost half. What remained has been converted to precious metals. When digital money disappears it simply vanishes. If the value of my metals drops to nothing, at least I still have a chunk of metal useful for throwing at politicians.

  13. WeAreGoingDownThe Pan says

    “it is very clear that falling prices are exactly what will ultimately stop the ‘hoarding of money’ and encourage spending again – spending on consumption goods and investment goods.”

    The trouble is old chap, that because we have an economy which is based on low wages for the 90%, and getting lower, and because the price of basic necessities such as heating, food, transport is going up due to those inconsiderate Asians wanting a piece of the cake hitherto reserved for us white folk, there is not much left for the 90% to use for spend spend spend. Without the majority doing that, we have more unemployment, more direct unemployment benefits required as well as indirect such as worsening health, more insecurity to promote hoarding amongst those who have a job paying more than basic rate etc etc.

    What you and yours fail to grasp, is that this particular crisis is like no other in modern times, simply because of the aforementioned inconsiderate Asians, therefore there is nothing in history to compare it to.

    Keynes will put off the crunch for a while, but inevitably the whole system will come crashing down unless the plebs in the so called west are prepared to put up with the workhouse for ever more, and that is something that history shows is unlikely to happen.

  14. Earlshill says


    I’d be interested to hear your view on Friday’s action by the BoE to forego(?) the interest due on the £375M of QE?

    • says

      Again, apologies for the slow response. This is a minor point. QE is a massive racket to begin with. This little accounting gimmick is of minor relevance in the big scheme of this entire disaster that is QE.
      Central banking is hugely profitable. You print money at no cost and buy assets that pay interest. QE is central banking on steroids: You print massive amounts of money at no cost and buy massive amounts of interest-bearing securities: Happy days! It so happens that most of the assets central banks buy are the bonds issued by their own governments (surprise! surprise!). So governments pay interest to the central bank and the resulting profit is payed back to the government which owns the central bank (in any meaningful way, although often not the direct or most straight-forwardly legal way). So what the BoE is doing now is an accounting short cut, similar to what the Fed and the BoJ do, and not too dissimilar to the Bundesbank. The central bank doesn’t even collect interest from the government to begin with. Just from a timing point of view, this is advantageous for the government. It eases near term stresses on cash-flow. But again, the whole set up of QE is scandalous and disgraceful. The interest accounting is only a minor racket by comparison.
      There was a rather pathetic article on the whole thing in yesterday’s Wall Street Journal Europe, which spoke about what would happen when (?) the BoE would hike interest rates again and sell the gilts. Then the government would have to compensate the BoE for any losses on the QE portfolio. Technically, this is correct. It will never happen. The government is bust and cannot pay the BoE. It is already the other way round: the BoE with its QE is keeping the government in business. When the public sells bonds and bond prices fall, the BoE will have to buy all of them to keep the government going. The system can’t cope with higher yields. Thus: there is no exit strategy for the BoE. The BoE will never be allowed to sell these bonds. Qe will continue ad infinitum. It is remarkable how delusional these journalists are about the state of the system…

  15. Kingbingo says

    “The crisis is evidently over. Home prices are going up! Come think of it, those London home prices will never fall. They can only ever go up! Let’s take our savings, take out a mortgage and buy now before the Bank of England makes them even more expensive!”

    You say that in jest, but in a purely elastic money system, why can’t that happen?

    I recently bought a house in London after having stayed out of the market for years. Not because I thought the price was attractive, but because I realised that the central banks were going to continue to print for many years, and that as a result of the inflation they would cause my real debt would be significantly reduced for me. I realized that printing was the only trick they had left after two decades of forcing interest rates lower, and two decades of ever increasing money printing would not surprise me in the least.

  16. Gerard de Bruin says

    I have known Richard Koo formany years when I was a client of Nomura, he is very sharp and intelligent, but his advice has been very costly to Japan. It was politically difficult to address the problem originated by excessive money, but Japan has only dug itself into a deeper hole. I totally agree with your analysis.
    A lot of money has gone upo in smoke, it is time to realize that.
    Recapitalize the banks, let assetprices find a bottom and get going again. Gerard de Bruin, The Netherlands

  17. says

    Maybe someone could illustrate here how an infrastructure project that would definitely bring direct benefits would be funded in Detlev’s economic model. I’m not suggesting Detlev’s wrong, but just seeking to understand.

    If this has already been done, perhaps someone would point a link at it.


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