The confidence trick – Steve Keen

Another must read piece from Steve Keen. SK writes in clear and simple terms and his arguments are as simple as they are compelling as is his research.

I am neither an academic nor am I formally trained in anything. I can only claim a sense of observation and a capacity to cross reference information. I particularly enjoy SK’s writing because it resonates with my stance and it allows me to see what I observe in real life is borne out by academic research.

Salient excerpts:

Three years later, he [Irvin Fisher] reached the conclusion that he had been misled by two core elements of the neoclassical theory he had helped build: the beliefs that the economy was always in equilibrium, and that the debt commitments borrowers had entered into to purchase financial assets were based on correct forecasts of future economic prospects.

On equilibrium, he reasoned, even if it were true that the economy tended towards equilibrium, random events alone would ensure that all economic variables were either above or below their equilibrium levels. Therefore economic theory had to be about disequilibrium rather than equilibrium:

“Theoretically there may be— in fact, at most times there must be—  over- or under-production, over- or under-consumption, over- or under spending, over- or under-saving, over- or under-investment, and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “ stay put,”  in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave.(Fisher 1933)

two dominant factors [are …] over-indebtedness to start with and deflation following soon after… these two economic maladies, the debt disease and the price-level disease, are, in the great booms and depressions, more important causes than all others put together.

Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation.

The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.” (Fisher 1933)


From Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience. Given over-indebtedness and low levels of inflation, a “chain reaction” would occur in which:

“(1) Debt liquidation leads to distress selling and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a “ capitalistic,”  that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoardinq and slowing down still more the velocity of circulation.The above eight changes cause

(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Fisher 1933; The Debt Deflation Theory of Great Depressions)


In the credit-driven real world in which we live, aggregate demand is the sum of GDP plus the change in debt. The public’s attempt to reduce debt meant that the reductions in debt substantially reduced demand, and this deleveraging was the unstoppable force that made the Great Depression “great”.


This is not good news for us today, for three reasons. Firstly, debt levels today are far higher than they were prior to the Great Depression–the force of deleveraging is thus likely to be greater now than it was in the 1930s. Secondly, given this higher level of debt, the correlation between the debt-financed proportion of aggregate demand and unemployment is even stronger now than it was during the Great Depression.

A final note. If you read the entirety of the article as you should, please note that in placing “unemployment” data on the graphs, the scale has been inverted so as to better show correlation.


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