Real Crisis Not Inflation (Uncut) 02-13-2025

Real Crisis Not Inflation, Tariffs; It’s Private Debt | Steve Keen

The economic theory on trade and tariffs is frankly nonsense. The cost of the tariff is paid by the consumer or it’s paid by the distributor. With a 10% tariff, you might see a 2 or 3% increase in the price of the final good.

And then the question is, which company is innovating faster? Chicago Fed President Austin Goolsbee said on Wednesday, February 5th, that it would be a mistake to ignore President Donald Trump’s tariff threats, which in his words could be dangerous. Now, Trump’s tariffs, a key part of his industrial policy, have stoked inflation fears among investors. We’ll talk about how impactful tariffs may actually be on inflation.

Our next guest said that inflation is more complicated than simply supply shocks and the money supply. The Fed has failed to get inflation right. He said his name is Steve Keen.

He is a professor, honorary professor at University College London and the visiting scholar at the University of Amsterdam. He’s also the publisher of Building a New Economics, which you can find on Substack. Professor Keen, an honor to host you.

Thank you for joining the program. Thank you for the invitation. Let’s start by talking about what your response is to the comment that I read in regards to inflation and tariffs from Mr. Goolsbee here.

Take a look at my screen, Professor Keen, and we can react to this together. So, this is top Federal Reserve official says it would be a mistake to ignore Donald Trump’s tariffs. A top Fed official warned it would be a mistake.

Austin Goolsbee, president of the Chicago Fed on Wednesday said that central bank’s tendency to follow pure economic theory and ignore supply shocks such as tariffs was dangerous. The U.S. faces a series of challenges to the supply chain, Goolsbee said, including strikes and natural disasters. Well, natural disasters aren’t really a function of tariffs, but the economy also faces the threat of large tariffs and the potential for an escalating trade war.

These threats are not of the scale of what occurred during the pandemic, but passing over their potential consequences would be a mistake. What is your response to this? Are you concerned about disruptions to the supply chain and what that could do to the price level of consumer goods? I might actually go back to the beginning of the statement he made there, if you can just scroll up on the screen a bit. Because one thing he said there is that the central bank’s tendency to follow pure economic theory.

Now, normally, if an engineer follows pure engineering theory, that’s a good idea. When you look at what pure economic theory is, the economic theory on trade and tariffs is frankly nonsense. I’ll give a quick reason as to why.

And that is that it all started with David Ricardo, but of course, economists have developed a more elaborate theory than they had Ricardo had at the time. But the basic thrust is simply the idea that countries should specialise in what they’re best at. And that’s, if you think about, you’re specialising as a broadcaster, I’m specialising as an economist, at the personal level, that makes plenty of sense, which I think is why we fall for this argument.

When you look at countries, what they’re talking about is countries specialising by moving their capital below a tariff barriers, which has been the whole thrust of economic theory, pretty much for the last 200 years. They’re saying, lower the tariff barriers, you will then move capital from where you are not particularly good. And the example that Ricardo first gave was England producing wine.

And everybody’d have to agree that England is not very good at producing wine. Move across to what you’re good at, which is cloth. Portugal, which is good at producing both wine and cloth, is comparatively better producing wine.

They should shift their capital from producing textiles to producing wine. And the English should shift their capital from producing wine to producing cloth. There’d be more of both, everybody’s better off.

Slight weakness in that theory is that it’s quite easy to imagine you can move labour from one industry to another. You can train a vineyard to be a shepherd and vice versa. But how do you turn a wine press into a spinning journey? The capital, in other words, is specific to each industry.

And you can’t reallocate. If England reduces its production of wine, they can’t turn their excess wine presses into spinning jennies. The capital rots.

You don’t actually transfer the capital. And this error, you would think is something an economist, so terribly sorry. Yes, that’s right.

We should take account of the fact that capital is immobile between industries. You can move machinery from one country to another. That’s not very hard, but it’s impossible to move machinery from one industry to another.

Well, rather than doing that, they continue assuming that you can turn a wine press into a spinning jenny. So their theories about specialisation are simply wrong. And when they try to fit their theories to the data, the modern theory is called the Hechler-Ohlin theory of trade, they find that the theory is contradicted by the data.

And I just actually watched a recent video by a bunch called Marginal University, and they said that theory has been in crisis by not fitting the data to 60 years. If your theory is wrong for 60 years, you’ve got the wrong theory. So the advice they’re giving about tariffs causing decline in trade by not enabling companies to specialise is simply wrong.

The real impact of tariffs, and this is where it’s still an open question for what Trump’s policies will do, is what it does to investment. Will those tariffs inspire American corporations to invest in the industries, which until recently, China has dominated instead? Now, it is feasible that what Trump is trying to do is to get production to relocate back from being offshore, where American companies moved it over the last 40 years, and bring it back onshore again. And it’s feasible that that would work, but there are all sorts of difficulties that have come out of it as well, mainly because now the global supply chains are so long and so complicated that one product like the Apple iPhone, for example, has commodities from about 120 countries inside it.

And there’s pieces exported out and re-imported back and forth between countries, but staying inside the same company. So it could actually drastically increase their costs as well. So it’s a simplistic tool, which may have unintended consequences, but I don’t think you can trust mainstream economists as to what they will be.

I’d be mainly concerned about disrupting the supply chain, but what Trump is trying to do is bring that back onshore to America. And frankly, America’s been de-industrialised in the last 40 years. It does need to reverse that direction.

Let’s come back to inflation in just a minute, but I want to talk about what you brought up, which is David Ricardo’s theory of comparative advantage. What if someone were to say to you, Professor Keene, I believe that the US has an absolute advantage over its trading partners, meaning that it’s not comparatively better at producing wine or steel or cloth or whatever the case may be. It’s just better at everything.

And so it is to their advantage to institute protectionist measures because they’re pretty much self-sufficient and can bank everything better than everybody else anyway. David Ricardo I would have been true 40 years ago. And the theory itself actually talks in favour of relative advantages, and I think it’s nonsense.

You can just ignore what economists argue on that front. But if you look at the absolute advantage, America had that 40 years ago. Now, when you look at China, China’s got that advantage.

There are so many industries where China is well ahead, both technologically and in terms of cost of production in commodities. So it’s a bit late to be asserting absolute advantage. If anybody has absolute advantage in the manufacturing sector these days, it’s China.

What about in tech? David Ricardo In tech, you’ve still got, for example, why is all the worries about WeChat? Why are we using WeChat rather than Skype? WhatsApp, et cetera, et cetera. Line, which is another one which is very popular in Southeast Asia. There are areas, yes, Americans were first with Google and with all the search engines and and computer software like Microsoft and so on.

But in many ways, if you’re looking at where the innovations are taking place now, they’re taking place in Asia rather than America. Even with we saw the hype over artificial intelligence, large language models, America took the front running and suddenly they’re afraid of a Chinese invention, which has actually fairly cleverly just reduced the amount of data that’s necessary to process to find answers much more rapidly on much cheaper technology. So America began with the advantage in AI, what, about six months ago? It’s already lost it to China.

Frank Curzio Then generally speaking, would you be in favor or oppose the institution of tariffs for America’s interests in Trump’s words, the America first policy? David Ricardo What I would be in favor of is industrial policy for America, because a large part of the argument against tariffs is saying, the government should keep its hands out of the industry. Governments can’t pick winners, et cetera, et cetera. But if you look at what’s actually happened in countries like South Korea, for example, the reason we have Samsung as such a major presence in the global telephone, mobile phone industry is because when the internet started to become heavily active, the South Korean government insisted that every house in South Korea had to have a T45 junction.

In other words, an ethernet cable. I had a very amusing experience of actually having the head of the Communist Party of South Korea visit me, very much a Soviet apparatchik type, to come to some of my lectures. And when I got in a room in Sydney, in Australia, he went around the walls trying to find where to plug his T45 cable in.

I had to tell him that Australia didn’t, let alone didn’t have cable, you still had to work with 9600 board modems on this incredibly primitive level. Because every house in South Korea had a T45 connection, very high speed internet, that’s where companies like Samsung came from. So you can actually say we’re going to put the investment into the growth industries.

And Southeast Asia and China as well have been incredibly successful in doing that. The laissez-faire attitude that America’s had hasn’t worked. And in fact, what’s happened is American corporations have relocated production to take advantage of initially low labor costs in third world countries, China obviously being the most important.

That has actually been used by Chinese corporations to industrialize. So there’s been the battle over whether you do or do not have industrial planning. The ones that have industrial planning, industrial development policies, they’ve succeeded and America has failed.

Okay, well, let’s go back to this article from the FT. I brought this up because the conversation that I want to shift to now is monetary policy. Goolsbee is, of course, the Federal Reserve governor for Chicago, president rather.

But his statements echo a lot of other economists’ sentiments, which is that most private economists expect tariffs to be inflationary and expectations for Fed rate cuts this year have fallen considerably since autumn. Following the decision to hold interest rates in the 4.25% to 4.5% range, Powell, Fed Chair Powell said, we don’t know what’s going to be tariffed. We don’t know for how long or how much, what countries.

We don’t know about retaliation. We don’t know how it’s going to transmit through the economy to consumers. Can you maybe shed some light and answer some of these questions that Powell has posed in his last press conference? How do you expect tariffs to transmit to consumers? Well, one of the main points, one of the few points I’ll agree with economists on in their critiques of Trump on the tariffs is that the cost of the tariff is paid by the consumer or it’s paid by the distributor.

When you import a good, Trump seems to believe that if you put a tariff, the country doing the exporting has to pay the tariff. No, the company that buys from that country has to pay the tariff to get the goods transferred out of customs into the warehouse so they can distribute them. So if you put the prices up by 10% that the wholesaler has to pay in America, then the wholesaler has a choice, do I pass that price on to consumers or not? So in theory, how does that, so how would that hurt China then? If American importers have to pay for it, yeah.

It can basically mean that American importers look at it and say, oh God, buying that VVD car is too expensive now, 10% more expensive. I’ll buy, I’ll distribute Teslas instead. So that’s a feasible shift.

But the question is how big is the cost advantage that China has in those areas? And when you look at autos in particular, VVD, which six or seven years ago, Elon Musk was laughing about, VVD is now cost competitive, substantially more cheaper than buying a Tesla. It might not have full self-drive, but it’s much, much cheaper and much better. Consumer technology is extremely high standard in the interior of the car.

They might say, well, look, I’m going to want to hang onto the market. I might put the prices up two or 3%, but I won’t go back and up by 10%. So there’s a decision by the people buying the product of the foreign company as to how much of the tariff that they have to pay that they pass on to the consumer.

And often that ends to be of the order of one or two, one third or less of the interest in price because manufacturers and wholesalers do have a large markup that they can actually sacrifice not to lose market share. So you might, with a 10% tariff, you might see a 2% or 3% increase in the price of the final good. And then the question is, which company is innovating faster, whose prices are falling over time? At the moment, I’d back the Chinese to drop their prices over time rather than the Americans.

So that cost disadvantage could disappear fairly rapidly. It is possible though, that a wholesaler or an importer in America could pay 10% or 50% more, whatever the case may be, but not raise their prices. In other words, they would just eat up the margin loss.

And so there would be no impact to consumers. How likely is that scenario? I think not no impact, but a much, much smaller impact than the full increase of the tariff. Again, conventional economists talk about perfect competition and imagine you’ve got a fairly complete pass through of any tariff increase under the final consumer prices.

The reality is that there’s an operating margin most producers and wholesalers have. They can lose a bit of that margin to hang on to market share. So given effect, again, you’ve got this big intrusion, like in the automobile industry, so many Chinese car companies now export into America.

The odds are they don’t want to get much damage out of that. They might pass on one third of the increase. They certainly won’t pass on 100%.

Take a look at what Trump’s had to say about deficits. Now, he is concerned about trade deficits with NAFTA trading partners, Canada, Mexico, which is one of the reasons why he wants to implement tariffs. Take a listen.

We’ll react together. We’re going to be demanding is we’re going to be demanding respect from other nations. Canada, we have a tremendous deficit with Canada.

We’re not going to have that anymore. We can’t do it. It’s I don’t know if it’s good for them.

As you probably know, I say you can always become a state. Then if you’re a state, we won’t have a deficit. We won’t have to tariff you, et cetera, et cetera.

But Canada has been very tough to deal with over the years. And it’s not fair that we should have a 200 billion or 250 billion dollar deficit. We don’t need them to make our cars and they make a lot of them.

We don’t need their lumber because we have our own forests, et cetera, et cetera. We don’t need their oil and gas. We have our we have more than anybody.

So, you know, just as an example. OK, so first of all, I look this up in the trade deficit with Canada is not 200 billion. It’s much less.

But that aside, why is this a concern for the president, a trade deficit with any country? Look, that’s a function that I’m agree with Donald Trump on this front. The trade deficits matter more than budget deficits, because when you’re running a trade deficit and you’re not the international currency, of course, America is the international currency. If you’re running a trade deficit, that’s got exactly opposite effect of running a government deficit.

What you’re doing is destroying money. Money is passing out of your economy. You have less to invest.

You can grow less effectively. So I’m actually a critic of trade deficits. Budget deficits are actually a good idea.

Trade deficits, I see, is a bad idea. And that puts me in a different camp, not just a neoclassical economist, but also what’s called modern monetary theory on that particular point. But the trouble with America, America, because it’s the international currency and America insisted upon that at the Bretton Woods agreement, what Keynes wanted to have was a neutral international currency called the Bancor.

The Americans insisted on using the American dollar. What that means is there’s a demand for American dollars over and above the demand for American goods. You need American dollars to trade.

That means the American dollar gets overvalued, which makes American manufacturing less competitive globally. So it was actually a stupid idea by the Americans, driven more by ego than by sensible thinking, to become the reserve currency. It’s a curse to be the reserve currency.

It means your manufacturing sector has to deal with a higher exchange rate than would otherwise face. It’s less competitive. And over time, America has necessarily run a deficit to give people American dollars to do trade globally, not just with America, but with every other country on the planet.

So I think it’s a foolish decision. The best thing Trump could do to reverse the trade deficit is to agree that the American dollar is no longer used for international trade. But I think there’s a snowflake’s chance in hell that he’d actually do that.

But that’d be the best thing to do. Stop being the reserve currency, find another system that would reduce the overvaluation of the American dollar and make American manufacturing more competitive. It just really means that American consumers are still strong and they’re needing to import a lot of goods from abroad.

It doesn’t necessarily mean the economy is weakening when you have a trade deficit. It is. It has weakened.

There’s actually a brilliant resource you might not know of called the Atlas of Economic Complexity, which is published by Harvard University. It’s done by computer scientists rather than economists. So it’s more interesting, more sensible.

And what they show is America has declined from something like about the eighth most sophisticated economy on the planet to about the 14th over the last 25 years. China’s risen from about 50th to 18th. So in terms of the sophistication of American industry, it’s declined.

What do you mean by sophistication, professor? It’s how complex the products are that they can manufacture. So the Atlas of Economic Complexity looks at just how sophisticated are the goods you make. The number one country in the world and has been for the last 25 years is Japan.

But Switzerland’s number two. Now, we don’t think we think about Switzerland about watches, high quality technology, pharmaceuticals, et cetera, et cetera. That small economy is more capable of producing sophisticated goods than America is.

And America’s been going backwards. Switzerland’s hold held its own. So has Japan.

So America needs to worry about just how sophisticated the goods are it can produce. And it’s gone very, very badly backwards on that front. It needs to reverse direction.

Interesting. I mean, Japan is another topic of its own. I mean, despite the sophistication of products it produces, the economy has not been growing to the same extent that it has been in the 80s and 90s.

So clearly it’s not as a result of a lack of sophistication of its industrial output, but something else. Correct? It’s had a bubble economy. America and Japan got caught up in the finance bubble back in 1980.

They actually deferred to the economy then as the bubble economy. You might remember that or maybe a bit too young to remember. But at one stage, the imperial palace in Tokyo, which is about 10 kilometers circumference, was worth more than California.

Now that bubble burst and private debt collapsed and you had a huge collapse in share market prices. What it also meant was the Japanese corporations were carrying too much debt to invest and they’ve stopped investing. So 30 years ago, there was a movie called The Rising Sun, talking about Japan taking over the world.

The bubble economy burst and, you know, the rising sun is set. So it’s letting the finance sector dominate your economy. That’s the real problem.

And frankly, that’s America’s problem these days. Take a listen to what Treasury Secretary Scott Bissett had to say about drilling for oil and its impact on inflation. Thirty second clip.

That is transport and the inflation, the actual inflation number, only single digits of that is energy. But in terms of consumers mind and especially working class Americans, that the energy component for them is one of the surest indicators for long term inflation expectations. So if we can get gasoline back down, heating the oil back down, then those consumers not only will be saving money, but their optimism for the future will allow them to rebuild their lives that they’ve they had to struggle with over the past four years.

Can you evaluate what he just said, Professor? Energy is an absolutely critical input to production of everything. One of my little sayings is that labor without energy is a corpse and capital without energy is a sculpture. So you’ve got to have energy as an input.

And if you don’t, you don’t have an economy. Mainstream economics, and he’s representing mainstream thinking there, ignores the role of energy. So it’s actually intriguing that he’s talking about it there.

He’s correct, of course, because a major cost for Americans, if you don’t have petrol in your car, you don’t go to work, you don’t go shopping. So it is the fundamental cost. But the prospects of reducing the cost of energy, I think, fly in the face of the other reality, which Trump is not aware of, and that’s climate change.

And at some point, the costs of getting energy out of the ground are rising. If you go back 100 years, you fire a shotgun at a rabbit and you get an oil well, the old Beverly Hillbillies line. Now you’ve got to put something down two kilometers deep off the coast of the Gulf of America.

And the cost of energy arising, the cost of getting energy out of the ground, that’s the real worry that America is going to have. We’re getting to the point where you won’t get enough energy return on energy invested to maintain an industrial, sophisticated society. But I wouldn’t trust economists to know what to do because they’ve always ignored the role of energy in production.

But how impactful is it going to have on overall consumer prices? Is it going to trickle down into, you know, coffee or other things, people, groceries? It will affect everything because you can’t produce anything without an energy input. So that’s absolutely critical. So energy is the most important commodity cost to which we’re going to determine inflation overall.

But we’ve been playing a silly game with energy for 20 years now with the shale oil revolution, which is why America is now an oil exporter rather than an oil importer in the aggregate. It imports different types of oil that it doesn’t produce domestically. But that is not sustainable in the long run.

We’re running out of the shale mines. You know, if you drill for shale oil, your reservoir runs out very rapidly. There have been technological solutions to that, but it’s still, it’s not a sustainable way to get energy in the long term.

What you’ve got to be moving away is away from dependence upon fossil fuels towards either nuclear at one extreme or some versions of solar at the other. And America has been doing that far more slowly than China. So in terms of energy, I think it’s losing out in competition with China as well.

Interesting. Let’s take a look at this chart here from the St. Louis Fed. This is the M2 money supply.

And my question is simply whether or not the money supply is a root cause of inflation. Take a look at the screen here. The money supply has contracted over the course of 2022 to 2023 and much of 2023.

And throughout 2024, it’s been on an uptrend, almost retracing its 2022 highs. Is this the beginning of higher consumer prices now that we have an increase in the money supply? Not all that much. I mean, the way that people think is that Milton Friedman argued inflation is always an error in monetary phenomenon.

And he blamed the increase in the money supply on the government. When you look at how banks actually function, governments create money by running a deficit and banks create money by lending up more than they take back in repayments. So a large part of the energy was created not by the government, but by private money lending.

And what you find is that the bank’s money supply in particular is response to prices rather than prices, money increase causing inflation. Inflation tends to cause an increase in the money supply. Money is accommodative.

It’s not a restrictive, it’s an accommodative thing. So you’ve got to be careful about what you use that money for. A lot of that is going into higher house prices, which isn’t helping anybody out.

So I don’t see the money supply increases being the problem. It’s the competition over the distribution of income that leads to those increases in the money supply. And at the moment, because of the level of economic activity caused by the deficit that occurred under Biden and because of COVID, that’s given workers a bit of bargaining power they haven’t had for a while.

That’s leading to higher wages. That is actually reversing some of the worries people have about inflation because workers are getting more in their paychecks. So it’s not a mechanical thing between money and inflation.

But if people were to say, Professor, we have here a pretty good correlation. If you take a percentage change from a year ago, if you overlay this particular chart in annual percentage change terms with the CPI in annual percentage change terms, there is usually a pretty good relationship or close correlation. How would you respond to that assertion? Largely because that CPI increase has been caused by increases in wages and increases in energy costs.

And that then feeds through to the money supply. We’ve got causation backwards, courtesy of Milton Friedman. And Milton Friedman’s model about what he called the optimum quantity of money made a whole range of assumptions that left the only possibility was that increasing money supply causes inflation.

But if you look in the real world where banks create money as well as governments, and bank money creation is at least two thirds larger than government money creation, that tends to be accommodative. And if firms have to pay higher prices for labor inputs or for energy, then they simply extend the amount of money they’ve borrowed from the government. And the increase from the banks and the increase in the money supply is caused by the inflation, not vice versa.

And if someone were to say, well, take a look at this spike in 2020, as you know, inflation peaked at 9.1% in 2021. That must have been caused by the biggest creation of money supply in Federal Reserve history. Surely there must be causation there.

How would you respond to that? When you take a look at what causes inflation, you can break it down into three factors. And Isabella Weber is somebody you should have on to talk about this, by the way. She has done much more detailed work than I have on this front.

But you can relate the increase in inflation to three factors, changes in markups by firms, markups over their cost of production, changes in money wages, and changes in the productivity output per worker. And what happened during COVID was a large plunge in output per worker. That’s what gave us most of the inflation.

Firms also put up their markups. Now that was made more feasible by the scale of government money creation during COVID. The government deficit hit 20% of GDP.

That’s the highest outside wartime. And that does increase the money supply quite directly. And that then meant that firms look, you know, you couldn’t sell a movie ticket for love or money because nobody was going to movie theatres.

Everybody was buying takeout. In that sense, the increase in money demand in firms said, oh, we can put our markups up. So one of my little lines about this is that people think money causes inflation in the same way that the NRA says guns don’t kill people, people kill people.

My argument is money doesn’t cause inflation, people cause inflation. But money can accommodate that increase in prices. And that’s what happened with markups under the COVID period.

Can you repeat the three causes one more time? You said changes in the wage growth. What are the other two? Yeah, the three are money wages, markups by firms over their cost of production and labour productivity or productivity per, well, I don’t like calling it labour productivity because there’s not workers being more productive, it’s better machines being used. But when you had with COVID, you had a real shock to all the supply chains.

And that increased the, that reduced the amount of output per worker, which increased costs. Right. Okay.

So when people, when reporters and economists alike said that the 9.1% in 2022 was a result of the supply chain shocks, that was, I guess that impacts labour productivity, but also markups from suppliers. It does. Actually, I want to point out one more thing you’ve got on your chart there, which is quite important.

That’s the, during the, during the global financial crisis, you see inflation rising before the crisis and then it plunges. Okay. Let’s make it so that you go from five point plus 5.6 to what is about minus 3%.

So we actually had deflation during the global financial crisis. Most people have missed that. You’re one of the few to identify it.

Now that was not, there was not a, there’s no change in government money creation. In fact, there was a big boost to government money creation as the crisis hit because the government’s automatic stabilizers, welfare payments go up, unemployment payments go up, tax revenue goes down, but we actually had deflation then. And that’s where people panicking, thinking I’ve got to get goods.

I’ve got to sell my warehouse rather than my rival’s warehouse. I dropped my prices. Everybody dropped their prices.

You get deflation while there’s a rising level of the money supply. So that’s, that’s the sort of, that is the canary in the coal mine against the argument that it’s all driven by government money creation. Right.

So let’s four QE’s if I remember correctly. Yeah. Four quantitative easing measures.

So this is the great financial crisis here. The M2 money supply rose dramatically in 2011, but we did not get significant inflation during the 2010s. Why not? Largely because inflation is as I said, is driven by competitions over the distribution of income.

And when you had the high unemployment we had after that, you had workers not being willing to risk putting a demanding money wages, money wage rises and firms thought they had to cut their markups to manage to get customers come inside their doors rather than elsewhere. So that was a period of suppressed economic activity. It wasn’t as bad as the great depression because government spending counteracted the downturn, but it didn’t stop it.

And we had five or 10 years of very low economic activity in that situation, neither workers nor firms are going to be trying to increase the share of national income. So you had quiescent wages and you had constant or declining markups. You said distribution of income is an important factor.

What about the distribution of wealth professor? Take a look at my chart here. This is the income, not income, but the wealth gap by wealth percentiles. And you can see that the wealth gap in America has been widening over the last several decades.

But this goes back to the nineties. But anyway, yeah, it’s huge. Yeah.

I mean, what does this do to inflation of anything? Well, what it does is it impoverishes people. You can’t have a mass consumption society of the workers are getting lousy wages. And if we look, we go back to the 1950s and you imagine your happy days and back to the future time.

Back then you had large families being supported by one worker. Now you’ve got small families where both parents have to work and they can’t afford to buy a house. So a lot of the insecurity and angst that Americans are feeling those days is because of this huge shift in income distribution from the working class to the ultra wealthy.

Right. And that is going to give you a stagnant economy as well, because the wealthy buy expensive stuff, but very slowly the poor buy lots of cheap stuff. You need to change the distribution of income back in favor of the middle class in America.

Sorry, just to push back a little bit. You said that this shows that people are being paid lousy wages. How does this show that people are being paid lousy wages? It always shows that the rich are getting richer, not that the poor are getting poorer.

When you take a look at the data in terms of the distribution of income in America, the share going to workers has been falling. The share going to the upper class has been rising quite dramatically. And one of all, this is getting a bit complicated for this discussion, but I’ve built models of what’s called Minsky’s financial instability hypothesis.

And one unexpected outcome of that model was that a rising amount of money going to bankers causes a smaller amount going to workers. And that actually turns up on the data as well. So by letting the financial sector rip and having far too much private debt, the impact of that has been more not by corporations, but by workers.

They end up with a lower share of GDP. So you’ve gone from being a mass consumption society to an elite consumption society. And I think that’s a large part of why the mass people are voting for Trump.

They’re voting for, you know, they’re throwing a ball into the China shop called Washington to try to disturb the direction America has been under for the last 40 years because the working class and the middle class have been screwed. So do you think that reducing the wealth gap, which is one of the campaign objectives of the Democrats, is actually supposedly a priority for economists or the government? It should be a priority, but I don’t trust the Democrats on that front. The Democrats became the party of Wall Street over the last 30 years.

And that’s, you know, they’ll say the right stuff and they’ll end up supporting Wall Street all the way through. So, but yes, that huge gap in wealth is a major problem for the American economy. How would you hypothetically reduce the wealth gap if you were the president? If that’ll happen in a billion years, what I’d do is I would actually use the government’s capacity to create money, which it has, which it does by running a deficit.

I’d use that to cancel private debt. The real problem in America is not the government debt, it’s the level of private debt. Everybody’s obsessing about government debt being 100% of GDP roughly right now.

Private debt’s 170% of GDP and nobody in the mainstream talks about it because they don’t understand private debt. It’s one of the focuses of my research and private debt is what causes financial crises. So the real thing I’d be doing is using the government’s capacity to create money to use that to cancel private debt and reduce the burden on people having mortgages, consumer debt, student debt, et cetera, et cetera.

Eliminate them, okay? You could do it with the government money creation and that’d give you a much, much wealthier middle class. I’m guessing you don’t think debt is a driver of inflation because it doesn’t transmit into one of the three causes of inflation that we talked about. Private debt definitely transmits into asset price inflation.

So the real cause of rising house prices is accelerating mortgage debt and that’s something which mainstream economists don’t understand. When I do the correlation between rising mortgage debt and rising house prices, I get a ludicrously high correlation out of the two and I’ve done the causal analysis as well. What causes rising house prices is accelerating household debt.

So it does feed through in that fashion. It can also accommodate when firms borrow money from banks to pay higher wages or pay higher energy costs, that does cause a rise in the money supply. But fundamentally, private debt inflates asset prices and the real problem for so many western countries, not just America, is house prices getting out of the reach of the middle class because we’ve turned into a speculative asset and the banks have done that.

We need to constrain the banking sector and this is the mistake we’ve made. We’ve let the banking sector rip and that’s a major part of why we have dysfunctional western societies these days. So you said earlier that a trade deficit would be more problematic than a budget deficit.

Let’s talk about the budget deficit now. The CBO, Congressional Budget Office, is projecting the deficit to reach roughly 6.2% of GDP by the end of 2025. That’s roughly in line with the 6.3% in 2024.

So they’re not actually expecting too much of a change despite the government’s efforts to cut spending. That’s the CBO’s projection. But let’s assume that their projection is correct.

Should this number concern you, the 6.2% of GDP? No, not at all. No, that 6% of GDP is, if you can sort of break it down into say, 3% real growth and 3% inflation, because the money supply, a growing money supply enables more commerce to take place. There’s no economy on the planet that has grown with a shrinking money supply.

So if you want to have a growing economy, you’ve got to have a growing money supply. And there’s two sources of money supply, increasing money. The government creates money by running a deficit.

The private banks create money by lending more than they get back in repayments. And you actually had too much credit money creation and not enough fiat money creation. So I’d actually be happy to maintain the deficit of the order of 6% of GDP and reduce the amount of money created by banks, because most of that money created by banks goes into share market speculation and housing speculation.

It makes housing more expensive. That’s not a good thing. So we’ve obsessed, we’re worried about government deficit and government debt.

We haven’t worried about private debt and private debt is a real problem. Let’s close out the discussion on what you think is going to happen to inflation, given the theories that we’ve discussed and what’s actually happening now. Are we heading towards a Fed’s 2% target or not so much? I think we’re more likely to stay around about the 3% level, but the 2% target itself is silly.

That was just a piece of a work by a guy called, an economist called Taylor, saying that 2% seems to be the target. That’s what central banks do. Let’s make 2% the target.

But one thing about money inflating is that it actually encourages you to spend. You don’t want to get, you know, VIMA or public levels of inflation. You don’t want to get 10% per annum rates of inflation, even.

But something in the 3% to 5% range, so long as it doesn’t accelerate beyond that, is quite comfortable. And because it reduces the value of money, it encourages more spending. You don’t want to get to the stage of wheelbarrows, obviously, but that rate of inflation of the order of 2% or 3% is quite comfortable.

The 2% target, the Fed has said, is too low. It should be what, 3%? I think, don’t worry about anything between the 0% and 4% range, 0%, 4%, 5%. Above 5%, I’d start to say that’s a reason to worry.

But the Fed obsesses about this. Why not target zero then? Zero is too close to deflation. And if you think inflation is bad, you don’t want to experience deflation.

Deflation occurred during the Great Depression. Prices are falling by 10% per annum. And what it meant was that even though people were paying their private debt down, the ratio of private debt to GDP rose because GDP was falling faster than people were paying their debts back.

And you look in the 19th century, there was a financial crisis every 10 to 15 years. You had prices falling up to 25% per annum. When prices are falling that fast, it’s because people are going bankrupt.

So you don’t want a serious… The one thing that the Fed and large government spending has done, we no longer experience sustained periods of deflation. And they were what led to crises and wars and all sorts of catastrophes in the 19th century. The Department of Government Efficiency has claimed that so far it is reducing government expenditures by up to a billion dollars a day.

It hasn’t provided a detailed breakdown of how it’s done that, but let’s assume that they are correct. It is as relevant whatsoever. I mean, I know that you’ve talked about private credit and how important private debt is in the creation of inflation, but is cutting government spending necessarily a step in the right direction to curtail the inflation? No, no, no.

I mean, there’s a lot of waste in government. I’m another great fan of bureaucrats. Plenty of bureaucrats would know that from past experience with me, but government spending and excessive taxation is necessary if you’re going to create fiat money.

That’s how fiat money is created. So if you’re trying to get rid of that, you’re trying to eliminate fiat money creation. That’s reducing the amount of money in the economy and you’re telling firms to grow more and sell more.

That’s going to only work if you increase the rate of turnover of money or you have more private money creation. And most of that private money creation goes into asset bubbles. So you’re actually, basically you’re throwing a knot around people’s legs and say, go run a hundred meters.

There’s a necessary role for a deficit to maintain the amount of fiat money in the economy. And economists and Musk, Musk does not understand that. They’re making, even you do the accounting and you look at what, whether the government actually borrows, government selling bonds is not borrowing money.

He’s got the accounting wrong. And government debt is never going to be unpayable. So long as that debt is in your own currency.

So Musk has got his mathematics wrong that way. He’s being a very bad engineer when it comes to money. Well, it’s been a great talk, professor.

Let’s close off on this final question. What would you, what would you say should be the government priority either from the federal reserve or from Congress in order to just make the standard of living better for Americans? We’ve talked about a lot of issues, but if you could wave a magic wand and just make everything better, what would it be? Well, one thing I said, I’d be reducing private debt by using the government’s money creation to cancel private debt. Change from government debt is easy and sustainable.

Private debt is not. So reduce the private debt burden on the middle class and the working class in America in particular. I think you also got to look at the intention to increase the amount of domestic production in America.

I think it’s a sensible idea because you have de-industrialized yourselves over the last 40 years by transferring production to China and China’s then outgunned America dramatically by doing the investment American corporations cease doing. You need to improve your engineering standards. So that idea to bring production back on shore to produce more domestically and also to start using, to start moving away from fossil fuel energy towards nuclear and towards solar.

Those are the sorts of plans you need. Okay, perfect. Thank you very much, Professor Keene.

Where can we follow your work and study, I guess, more from you? Well, I’ve got my Substack and Patreon pages, Prof Steve Keene at both Substack and Patreon. And I also am putting online courses these days. I have to apologize for how heavy handed the marketing is.

That’s out of my hands. But if people want to come on and do courses with my non-orthodox approach to economics, go to this website called book.profstevekeene.free and that’ll get you to my courses. But as I said, please, I’m apologizing for the marketing.

It’s a Canadian marketing company of all things that’s being a bit heavy handed there. But the product behind it is genuine. Absolutely.

We’ll take a look at your course link down below. So, follow Professor Keene there. Thank you very much for your time today.

We’ll speak again soon. Take care. You’re welcome, David.

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