Paradigm Shifts. by Francis Lee for The Saker Blog. June 22, 2020.
INTRODUCTION:
I first wrote this article in 2012 and have had to make a number of minor alterations. Of course a great deal has happened since that time, most of it bad. We now seem to stand on the threshold of an even bigger and deeper crisis than in 2008, plus additional worrying features, viz. the pandemic and possible future pandemics as well as increasing and widespread economic and geopolitical instability. The crisis portents were always there but both the PTB and the populations at large did not seem unduly concerned about these developments which were taking place and maturing through the post-2008 period.
Paradigm Shifts
Some years ago I reviewed a book – State Building – by one Francis Fukuyama. This was one of Mr Fukuyama’s lesser known works, he is more famous for being the theorist of the ‘end of history’ – a view promulgated during the halcyon days of the neo-liberal counter-revolution circa the 1980s. After the collapse of communism in Eastern Europe, and with social-democracy effectively throwing in the towel in Western Europe, Mr F postulated that liberal, deregulated, market capitalism was now the historical norm, and if countries had not arrived at this terminal point in their history, then in the fullness of time they surely would. In short this is when one paradigm or epoch ends and another one begins. Certainly, the world underwent a both quantitative and qualitative paradigm shift in 1980s an historical shift which has lasted for at least 4 decades.
This current view was to become the received wisdom in official circles, and I would argue that in a contingent sense still is, at least among the political, financial and media elites. But it could be plausibly argued that this current paradigm is in secular decline and a new paradigm seems to be emerging. That is why we study history. Epochs come and go. Whether this will be for good or ill is an open question. Paradoxically, the established paradigm – let’s call it the Thatcher/Reagan settlement – represented almost a theoretical mirror image of the cruder types of Marxist historical materialism. Of course, both were extremely contestable since the human agency was excised from the historical process; a process apparently beyond human volition and control; almost a force of nature. It followed from this, therefore, that politics was no longer about choice, according to the post-modernist fraternity, the grand political narratives were at an end; henceforth politics was to be simply about administration: the relevant question being who could run the system more efficiently. How simplistic and facile these notions now seem.
To be fair Fukuyama has now admitted that he was wrong, and the more humanistic interpretation of Marxism – as espoused by inter alia Georgy Lukacs and Antonio Gramsci – does allow for human intervention in the historical process, in fact it insists upon this. Marx also, at least in his early years, put forward the famous dialectic. ‘Men make history, but they do not do it as they please.’ This is to say that they were creatures of their time and made political choices, but these choices were historically conditioned and constrained.
However, it seems commonplace among the journalistic types and other jobbing mediocrities to think that history is something in the past and that the present is the point of arrival; a tendency to take the empirically given as somehow natural and inevitable; its permanence taken for granted. And of course those who have most to gain from the present dispensation will fight tooth and nail against any attempt to change this state of affairs. Reforms are possible – even though these will be generally opposed by these same entrenched interests – but the fundamental structures and institutions of the system will be left broadly unchanged. This is true at all times and in all places, including our own.
We can say, therefore, that the world crisis of 2008 and its various explanations were thus all based upon the notion that the neo-liberal capitalist order is inevitable and permanent. Even erstwhile radicals like Will Hutton of the Guardian and Paul Krugman of the New York Times believed this to be the case. These are essentially mainstream Keynesians, who argue for a more regulated capitalism which they regard as viable, whilst their opponents the free-market Hayekians – Peter Schiff and US libertarian Ron Paul – believe in less or even no regulation. But of course both schools are committed to the capitalist system so the argument has been something of an in-house debate between the two establishment viewpoints.
That the system is in a protracted and long-term crisis is self-evident. But the contending viewpoints above are posited in a rather narrow and orthodox spectrum of economic theories which I think fail to address the depth of the predicament.
The Hayekian/Von Mises Austrian school
For a long time after the Second World War these particular theorists were exiled to a virtual leper colony of macro-economic theory. This was a period of the Roosevelt/Attlee settlement, the spread of communism over Eastern Europe, China and Indo-China. The catastrophe of depression/fascism/war, all emanating from uncontrolled markets and market crashes, followed by trade wars of the 1930s and then the shooting wars, was rejected absolutely by the electorates of the western world as well as by their leaders. But Von Mises, Hayek, et al. bided their time until their moment came. This moment came in the 1970s when the post-war boom petered out. They found a populariser of their beliefs – albeit in crude form – in Milton Friedman of the Chicago School and what was called monetarism. These ideas then migrated from academe via the broadsheet press and finally to the right-wing political parties at the time headed by Thatcher and Reagan.
The Austrian school believe that attempts to control capitalism through state intervention will fail and will in fact be positively counter-productive. This is because such interventions distort the price mechanism leading to misallocation of resources, inflation, and asset price bubbles. A good example of this would be the credit/property boom (2008) which was enabled by the accommodative actions of the Central Banks and Treasuries around the world, but particularly by the Bank of England and the US Federal Reserve Board. Interest rates were kept low and both heads of the two respective central banks as well as Treasury officials, in the UK’s Labour government, Gordon Brown and Edward ‘light touch regulation’ Balls in the UK, and the Fed boss Alan Greenspan in the US. Thus the natural cyclical tendencies immanent in the capitalist system were given an additional push by government monetary policy. Why? The answer is disarmingly simple: booms and bubbles (at least during the up-phase) are popular with the masses and are therefore good politics. Who can ever forget ‘the-end-of-boom-and-bust’ triumphalism of the period? However, the Austrians continued to argue that booms and busts are intrinsic to the system. One cannot exist without the other. During the boom phase of the cycle investors and consumers tend to become overconfident and make foolish investment and purchasing decisions. Prices start to rise due to the continual demand for factor inputs, growth becomes more and more febrile, banks make foolish loans and acquisitions (Northern Rock and the Royal Bank of Scotland come to mind), and then, when rises in income can no longer support rises in asset prices, the whole thing collapses. This is what happened in 2008. The bust part of the cycle then begins. All the bad investments and overspending now come to light. Companies go bust, unemployment mounts, debts are written down simply because debtors cannot pay, and all the misallocations of resources can clearly be seen with half-finished empty houses standing as the self-evident physical symbols of the manic bubble period which preceded them. Here Andrew Gamble explains:
It was argued that full recovery would not be achieved by bail-outs, Keynesian deficit spending, or by rescuing companies which were simply inefficient or did not supply consumers or investors with their preferences as demonstrated by the market price mechanism. Such policies would simply create ‘moral hazard’ a tendency for investors and consumers to carry on as usual with their losses being underwritten by the state; in this situation there was no intention or incentive for improving their business efficiency. These bailed-out entities were the economy’s living dead, kept alive on state support – zombie banks as in Europe and Japan and zombie auto companies like Fiat, Kia, and GM, or insurance companies like AIG, all of which should have been allowed to fail. With their failure more competitive efficient companies would arise in their place.
Recovery could only get underway when, as during classical depressions, prices fell, which meant that if wages and interest rates fell more slowly – if at all – then disposable income would start to increase. This being the case consumers would start to spend again and businesses start to invest. Similarly bankrupted and distressed firms would be bought out at fire–damage prices by the more efficient and larger firms with more up to date equipment. Growth now resumes given the destruction of existing capital values. The process of accumulation can restart.
What is striking about this (Austrian) theory is its similarity to Marx’s view of trade cycles, and also to those views espoused by Schumpeter. But much of both theories were formulated in an earlier phase of capitalism. But for all that the Austrian theory’s analysis of the bust is quite plausible and sophisticated.
Summing up the Austrian view, capitalism is intrinsically cyclical. The Growth periods tend to run out of control resulting in bad investments and resource misallocation. This process is fed by easy credit and excess liquidity. Asset price inflation rises to a level which can no longer be sustained by rises in income or further borrowing. The boom turns into a bubble and the bubble bursts. Then the whole process swings into reverse – the bust has arrived. However, the bust rectifies the situation by liquidating all the mal-investments and making way for a reconfiguration of the system on a more sustainable and efficient basis. Capitalism restructures itself through these types of crises.
Prescriptions
Although the Austrian (and indeed Marxist) analysis of the bust is, I would argue broadly speaking correct, but the future policy prescriptions of the Hayekians seem frankly alarming. The scope and interdependence of the system is such that the notion of simply letting the bust take its course would lead to quite massive economic, political, and social dislocations on a global scale – as would have been the case had world governments simply let the coronavirus pandemic rampage through societies and run its course in 2020 – such a policy would dwarf the depression of the 1930s and 2008. In a strictly logical sense the reasonings of the Austrian school are correct, but their policy prescriptions are simply too terrible to contemplate.
So what about the alternatives?
John Maynard Keynes and his followers
Well I think we need to clear up one or two things about Lord Keynes before we start. Keynes was emphatically not a socialist, if anything he was actively hostile to socialism. He opined that: ‘’The class struggle will find me on the side of the educated bourgeoisie.’’ (4) We might legitimately enquire who, apart from Keynes himself, might be the ‘educated bourgeoisie’ exactly! Further, The Labour party is a class party, and that class is not my class. Again, How can I adopt a creed – Socialism – which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement. It seems necessary to state this because of the widespread belief on the left that Lord Keynes was indeed some sort of (closet)-socialist. This could not be further from the truth: Keynes main aim in life was to save capitalism from itself.
His magnum opus, ‘’The General Theory of Employment Interest and Money’’ first published in 1936, represented the culmination of his earlier writings in which he elaborated what he believed to be the problem situation which had arisen in the world economy during the 1930s, and what he believed to be the solutions. But Keynesianism is not really a theory of the trade cycle, nor is it a general theory (more of which later) it is more a theory of boom/bust and possible ways out of economic depressions. The bust period in a capitalist economy generally follows a period of excess credit and hence debt-fuelled growth. This was the case during the roaring 20s with runaway credit (debt) fuelling growth until – pop went the weasel! Credit duly contracted as the defaults multiplied, and so the Roaring 20s transmuted into the depressed 30s.
Post-crash, the problem was not excess demand but insufficient demand. This became known as debt-deflation. This is where Keynes and his co-thinkers entered the scene. With consumers and investors not spending, aggregate demand in deflationary conditions is flat, or even falling. Therefore the solution could only be increased spending by the government. This to be carried out by a mixture of monetary policy (lowering interest rates and Open Market Operations, and now Quantitative Easing – QE) and/or fiscal policy (taxation and public spending). This is of course something of an oversimplification of Keynes’ theories which were somewhat more radical than most of his enthusiasts found to their taste, but it broadly captures the gist of what he said. The increase in aggregate demand would feed through to the rest of the economy and so induce an increase in output which would be eventually self-sustaining. Governments would find it necessary therefore to run budget deficits during this period. Q.E.D.
This approach was taken up by the Roosevelt administration when it came to office in 1933. At that time unemployment in the US stood at the alarming figure of 25%. A raft of policy measures including the Works Programme Administration (WPA), National Recovery Act (NRA), Tennessee Valley Authority (TVA) Civilian Conservation Corps, were implemented. Unemployment fell to 14% by 1936, but then rose again during a new recession in 1937/38 to 20%. So the track record of Keynes policies seems patchy to say the least.
The Long Boom and its collapse 1980-2008
In our own time we have seen almost a repeat of the 1930s debacle. The long boom of 1980-2007 was floated on a sea of debt. But even this period was punctuated by blow-outs, first in the Savings and Loans episode of the 80s and 90s, then the Long-Term Capital Management collapse in the 90s, and finally the dot.com bubble in 2001. The 2008 crisis was, however, seemingly worse than these events and more global than that of the 1930s. In 2008 the whole credit/property induced boom came to a shuddering halt when the sub-prime borrowers in the US defaulted. House prices, which, had been rising by double digit percentages since the early 90s collapsed in 2006 and have been falling, apart from one or two transient minor upturns, ever since.
The same was to also happen in Iceland, Ireland the UK and Spain who had also built their policies around house-price inflation. Mortgage backed derivatives – i.e., those financial products which were based upon these repackaged dubious mortgages were parcelled up and sold as new financial products to brain-dead investors around the world after being given the triple AAA seal of approval by the ratings agencies. These derivatives were only producing a stream of income so long has the mortgagees continued to pay their instalments – when they defaulted the derivatives became worthless, the banks, who among others such as pension funds who had been purchasing these debt instruments, then found that their newly acquired ‘assets’ had turned into liabilities overnight. Many banks were effectively insolvent, and the great bank panic of 2008 spread around the world.
Governments found it necessary to bail-out these institutions in order to avoid a global meltdown. So the banks happily transferred their junk ‘assets’ onto the sovereign nations’ balance sheets courtesy of the Central Banks. Needless to say this was only the opening of the great recession of 2008/09 which in spite of its putative ‘recovery’ still drags on. The crisis was to cross the pond from the US – whose fundamental problems still seem unresolved – to Europe where the problem became more acute.
Stabilisation and low growth 2009-onwards
Since the nadir of 2008/09 there has been a stabilisation rather than what we might meaningfully call a recovery in the global economy. Growth is flat or falling in Europe, although there are very marked regional disparities, and very weak (and as I write, beginning to actually stall) in the USA, again with regional disparities. Interestingly, perhaps with all the clamour regarding austerity in the eurozone, no mention was made in the 40 or so US states – some effectively insolvent – which oversaw swingeing austerity programmes, California and Wisconsin come to mind, as does Detroit, famous for Tamla Motown and auto-vehicle production. A one time industrial city of 2 million people became a ghost town of 700,000.
Concomitant with this there were high levels of unemployment on both sides of the pond. Official figures for US unemployment, as found in the Bureau of Labor Statistics (BLS) are completely fraudulent and always have been since whole swathes of de facto unemployed have been disappeared off the register simply by definition. (The same disappearing trick was used with the core inflation figures.) The BLS gives three levels of unemployment according to how the word is defined. In fact there are six definitions ranging from U1-U6. The BLS uses U3 but the figure for U6 is double. And if the same definition were applied as used to be the case then unemployment would be almost 4 times the official account. The same jiggery-pokery is used when defining inflation. Each redefinition gives a lower figure.
Regarding this universal practise, it was the late Conservative Member of Parliament and at one time member of Mrs. Thatcher’s Cabinet, Lord Gilmour, who once said of his government’s unemployment reduction programme: ‘’Now we have reduced the unemployment figures, perhaps we can make a start on reducing unemployment.’’ I am afraid the pollution of statistics is the same for inflation, GDP growth and various other economic statistics. These statistics are not some measurements of objective facts, but simply political constructions. (6)
In passing we should become aware of a new economic development which came into being after 2008 and persists to this day. This was the genesis of the so-called ‘gig’ sometimes called ‘sharing’ economy. It should be made clear that this sector of the economy is generally very much ’off the books.’ The modern workforce has become increasingly stratified. There are well-paid jobs for a small portion with the requisite skills, but the vast majority of new employment is in the low-paid service sector, such as retail, leisure, hospitality, age-care and health-care. The sharing-economy is generally part of the informal sector but requires abundant cheap contract labourers to be available at the touch of a smartphone screen. Fulltime employees with normal benefits would make the model unworkable. This ‘gig’ or sharing economy exploits low-wage workers in a weak economic environment. This new ‘eke-onomy’ consists of individuals renting out their houses, cars, or labour make only a fraction of what they would receive in traditional full-time jobs, without any employment benefits. This is what Marx/Engels termed the industrial reserve army consisting of the unemployed and under-employed. Moreover, in the UK at least most of the workforce engaged in this low-paid, insecure drudgery are for the most part, immigrant labour, often illegal, from Romania, Spain, Portugal, Poland, the English-speaking part of Africa and even as far as China. Welcome to the ‘smart’ economy.
Keynesian policies … and debt levels
The general Keynesian response to the downturn has been a hue and cry for stimulus at all costs. Keynesian counter-cyclical policies traditionally consisted of 1. Monetary policy. This comes under the remit of the Central Bank and consists of control of interest rates and money supply. 2. Fiscal policy, which is the remit of the Treasury consisting of taxation and public expenditure. Sotto Voce It should be noted at this point that the Central Banks became the source of economic policy. This was a new departure since it meant that fiscal policy was relegated to a secondary role in economic planning. Monetary – i.e., central bank – policy now ruled the roost. The rigidly orthodox European Central Bank (ECB) – more catholic than the Pope – adopted hard-nosed monetary policies in the eurozone with alacrity, whilst the Anglo-American approach involving monetary and second-tier fiscal policies were partially adopted in the UK and more rigorously in the US.* The ECB put the weaker economies in the eurozone – Greece, Spain, Portugal, Ireland, Italy, Latvia – through the wringer of a grinding depression. No stimulus policies were undertaken, since it is argued this would pile more debt onto unprecedented levels already extant. Results have, to say the least, not been exactly encouraging, particularly in the southern European periphery. This situation has received press coverage ad infinitum much of it justified, but much incredibly biased and ignorant, but hey, this is the white noise of democracy in action.
Given that the eurozone crisis has received saturation coverage we will move on to the UK. Here we have a bizarre mismatch of policies: a loose monetary policy with the Bank of England lowering the base rate to 0.5% and engaging in money printing – otherwise known as Quantitative Easing – and a tight fiscal policy with the Treasury cutting back on public spending. The result? The worst of both worlds, inflation, and – good old 1970s stagflation.
The poster child for the Keynesians was the United States which threw everything but the kitchen sink at the problem in both fiscal and monetary terms. This produced some low growth and a slight fall in unemployment, albeit from an extremely high level, and recently reversed, but each additional stimulus has had less of an impact than the one preceding it. A sort of diminishing returns was to set in, whereby more and more of the ‘fix’ is needed to get any sort of result.
The Federal Reserve had already initiated 2 rounds of QE injecting literally trillions of $s into the economy. In addition it lowered interest rates to 0.25% – zero to all intents and purposes. The Fed’s purchase of paper assets was facilitated with the printing of paper monies. These paper assets consisted of US Treasury bonds and junk securities from government sponsored enterprises such as Freddie Mac and Fanny Mae, the two government agencies whose remit was to issue mortgages to prospective US homebuyers. This meant that the assets purchased by the Fed were nothing more than debt, unredeemable debt at that. This is a weird situation where the Fed was buying US bonds issued by the Treasury department so that the US Federal government could pay its current bills. And where did the Fed get its money from? Out of thin air apparently, it simply printed the stuff! When the stage is reached where governments have to pay their current expenditures by printing money then the alarm bells should start ringing. An idea of the monies involved was described as follows:
Suffice it to say that money printing has continued and massively expanded to the present day 2020. Increasing the supply of paper money in the economy in the absence of demand for it can only produce one result – inflation, albeit after a time lag. (But this works on the assumption that the velocity of circulation of such monies remains constant. If the circulation falls to zero, then there will be no inflation. Deflation is more likely if the money supply does not reach the real economy. If the rate of money circulation does not alter, we can expect inflation to appear.) It will be objected, however, that the US rate of inflation was at the time of the 2008 episode only 2.3%. True. But bear in mind that both food and fuel price increases are left out of the calculation in what is termed US ‘core inflation’; another egregious example of officialdom’s statistical sleight of hand. Were those price rises added in then at the very least the US inflation figures would almost certainly double. Moreover, the global effects of the Fed’s policies has been to export this inflation around the world as a mass of greenbacks flew out of the US looking for more favourable investment outlets. The global supply of these Eurodollars (i.e., US$s circulating outside of the US) had ballooned, and this led to an inflationary impact globally as food and commodity prices (notably oil) had spiked. This in turn led to food riots and political disturbances throughout the world, particularly in the Middle East. A sort of unforeseen justice was done, however, when higher oil prices hit the price of gasoline in the US – a boomerang effect. The inflationary effect of the Fed’s money printing also meant that local currencies were put under pressure. When the $ tsunami entered a country their own currency was subject to an upward revaluation, which meant a higher exchange rate. They were therefore faced with two choices: one, do nothing and let their export markets contract since their currency was now more expensive, or two, maintain the value of their currency against the US$ by purchases of more of these dollars with their own currency. This would mean that their own money supply would expand and become inflated. Thus US inflation had become global inflation. Yes, devaluation is a great way to start a currency war.
As far as fiscal policy goes the US has consistently run budget deficits since the 1990s when it actually recorded a small surplus. The cost of the government takeover of Fannie Mae and Freddie Mac, the cost of ongoing wars in the middle east, the cost of bailouts to various financial institutions, the cost of fiscal transfers to cash-strapped states and various stimulus programmes has raised the US budget deficit (2008 figures) to $15.5 trillion, which given that the Gross Domestic Product of the US as of May 2012 was $15.6 trillion, makes the ratio close to 100%. Even before the economic crisis, the U.S. debt grew 50% between 2000-2007, ballooning from $6-$9 trillion. Now the implications of this are indeed sobering.
According to the authors Reinhart and Rogoff when debt to GDP ratio reaches 90% this will constitute a drag on future growth. And bear in mind that this figure of debt-to-GDP has risen to 107% in 2020. Longer term implications of America’s chronic debt problem are manifest. Sure the Fed can print unlimited monies, but it can’t guarantee that these greenbacks will have any value.
Over the next 20 years, the Social Security Trust Fund won’t have enough funds to cover the retirement benefits promised to Baby Boomers. That means higher taxes since the high U.S. debt rules out further loans from other countries. Unfortunately, it’s most likely that these benefits will be curtailed, either to retirees younger than 70, or to those who are high income and therefore aren’t as dependent on Social Security payments to fund their retirement.
Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, anticipation of this lower demand puts downward pressure on the dollar. That’s because dollars, and dollar-denominated Treasury Securities, may become less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand.
The bottom line is that the large Federal debt is like driving with the emergency brake on, further slowing the U.S. economy.
Now if we add in private debt to the equation – i.e., the debts of household sector corporate sector, business sector, non-corporate businesses, State, and local government – then the debt soars to something like $50 trillion, or 363% of GDP. Then of course there is the chronic deficit on current account which adds a further dimension to the problem, and all of these seemingly intractable processes are still ongoing but hey, let’s not labour the point.
The seriousness of the situation is only matched by the complacency of the US authorities who seem to think they can go on raising the budget borrowing ceiling and that overseas investors will simply keep on buying their Treasury bonds forever. If ever there was a definition of unsustainable this is it.
In fact the structural problems in the US economy could well be fatal if these colossal debt levels are not reined in or simply stabilised. The US is being kept afloat by their ownership of the global reserve currency and the willingness (for now) of investors, mainly China, Japan and the oil-rich states in the middle-east to keep purchasing US Treasury paper – paper assets of dubious value and paltry yields. Overseas investors are aware of this situation and have begun to lower their exposure to the US$s and dollar denominated assets by diversifying into other assets and have also started to trade in their own currencies rather than the dollar. Straws in the wind perhaps, but indicative of future trends.
Taken by themselves Keynesian demand-side policies of stimulating the economy hardly begin to grapple with the problem. This is because deeper problems are on the supply-side not the demand-side of the economy. They can be classified as follows. Deindustrialisation as the manufacturing base is hollowed out or emigrates to cheaper venues; ageing populations; rising energy costs and scarcity; saturation of markets; lack of leadership at the political level; finance running amok; the ability to create paper money and assets without limit; an inadequately trained workforce; skills and investment deficit; and structural unemployment brought about by new technologies. And to crown it all there is the dreaded ‘Triffin Paradox’ to be factored into the equation, but this would take another article. Moreover, I could also have added in the issue of climate change but didn’t want to depress my readers unduly.
Keynesianism is fixated on the demand-side. But in a world beset by the sort of supply-side problems listed above traditional demand-management policies used since the war will not be effective. It is also worth adding that both Germany and Japan, where the wartime devastation was manifest both recovered strongly without Keynesian demand management. This actually serves to validate the Austrian and Marxist theory that upturns and booms in a capitalist economy are the result of the destruction of existing capital values. Japan and Germany roared ahead because their own industries and infrastructure was decimated, and they had to install the most modern up to date capital equipment and technologies and again start from scratch. Economies which start from a low base tend to have extremely high rates of growth.
I did mention earlier that Keynes’ General Theory is in fact not a general theory at all but a special theory. Such policies may have been appropriate for the post-war period with the usual cyclical movements of the trade cycle, but dare I say, this time it’s different. What we are now confronted with is a systemic global crisis of capitalism. In the present situation Keynesian policies – which are commonly understood and promulgated by his epigones – are unlikely to have the desired effect for the following reasons.
It has been calculated that growth would have to be at the rate of 6% per annum which when inflation is factored in reduces to actual growth of 2% to make any inroads into the huge debts. This seems very, very unlikely, although this is what the US authorities will attempt to do.
One final point with regard to Keynesian policies: They are often thought of as an alternative to austerity, when in fact they are simply austerity by other means. It is an open secret, though never admitted, that both the Fed and the Bank of England are attempting to monetize the debt levels in both countries. This entails keeping inflation one or more jumps ahead of wages, pensions, benefits, and interest rates. This inflation is engineered by the Central Bank which devalues the currency – supposedly to make exports more ‘competitive’ and printing money through QE. Devaluation leads to an increase in import prices which will tend to feed through the rest of the economy causing domestic inflation. The time-honoured claim made by the then British Prime Minister, Harold Wilson, in 1967 that the proposed 17% devaluation of the £ ‘would not affect the pound in your pocket’ was simply a barefaced lie. When a country devalues its currency it makes itself poorer (‘competitive’ is of course the preferred description). That is its whole raison d’être, and in this respect, it is no different from a policy of deflation.
Thus the disposable income of the mass of the population is effectively pushed down as prices rise, and the most acutely affected will be the poorer sections of the community or anyone who keeps their assets in cash. The more opulent, however, will be able to switch into stronger currencies, and physical assets such as precious metals, property, L’Objets d’Art which will appreciate in price. Inflation will help debtors since their debts will be effectively amortized, i.e. grow less as inflation lowers the magnitude of the debt. Of course the principal debtor is the government.
Forcing down interest rates to near zero in an inflationary environment gives savers two options. Do nothing and watch their savings melt away, or just go out and blow the lot. Similarly investors will be forced into more risky investments as they see the paltry return to safer bolt holes such as gilts being eaten away by inflation. It all rather sounds like a re-run of 2002-2007 credit-fuelled growth madness. And paradoxically, because disposable income is crimped by such a policy, aggregate demand falls, and this gives another push to deflation – the law of unintended consequences.
Keynesians see the problems of past and present capitalism as purely technical. They apparently believe that capitalism can be ‘fixed’ using appropriate tools and that it would therefore be possible to have permanent semi-boom conditions. This is clearly expounded by economists such as the American Keynesian, Paul Krugman in his book Peddling Prosperity, first published in 1994. Having spent most of his life during the post-war boom, he is apparently dumbfounded that it suddenly ended in the early 1970s. He intoned that … In 1973 the magic went away. Well ‘magic’ had nothing to do with it. Capitalism was beginning to enter into a periodic systemic convulsion which is now reaching its climax.
After Keynes – What to Do?
On the first point Schumpeter was at that time wrong, but it is now a question which needs to be raised again. On the second point, he has to be right. But this is a political rather than a purely technical question. The present crisis will be solved sooner or later (preferably sooner) but the question is how, by whom, and for whom?
The question for socialists, or for that matter any oppositionists to the present regime, is what should the strategy be for the coming struggles with this system – a system which cannot go on in its present form for the simple reason that it needs to grow at a compound rate of 3% forever – this is not possible for both political, economic and environmental reasons. Socialism or a collapse into semi-barbarism seems to be on the agenda once again. But we shouldn’t be surprised by this; it is surely what we have been expecting since the trouble started brewing in the late 60s. After all capitalism moves in huge cyclical convulsions, and this is one of them.
This is a colossal question and I can only allude to possible areas of political action. The first thing to realise is that the historical window for a social-democratic Keynesian solution to the crisis is now closed. It was only made possible by a specific conjuncture of political and economic circumstances. The Thatcher-Reagan settlement and globalization marked the death-knell of the Keynes/Beveridge consensus. (11) Does this mean that socialists should not support a policy of reform within the system? Not at all. But this support must perforce have in view the objective of forcing a paradigm shift away from what has been a trade unionist approach of simply gaining and defending reforms – to a struggle for real political and economic power.
The programme of the liberal-left – the type of journalism which we see in the Guardian and Independent and Labour party publications – actually advocates reform of a system which is beyond reform. It should also be clearly understood that such reforms as advocated by most of the liberal-left such as public spending on work creation programmes, investment in green technology, a national investment bank will only provide a temporary fix, and may well have negative downsides, such as inflation.
Keynesian reform will not be a long-term solution, but it can alter the political balance of power and shift the argument in favour of the 99%. The politicisation of the mass of ordinary folk can begin with such an approach. Socialists, however, need to go much further than the type of Keynesian stimulus programme as advocated by Hutton, Krugman, Elliott, et al. Such a programme might consist of the following set of workable policies.
For a long time after the Second World War these particular theorists were exiled to a virtual leper colony of macro-economic theory. This was a period of the Roosevelt/Attlee settlement, the spread of communism over Eastern Europe, China and Indo-China. The catastrophe of depression/fascism/war, all emanating from uncontrolled markets and market crashes, followed by trade wars of the 1930s and then the shooting wars, was rejected absolutely by the electorates of the western world as well as by their leaders. But Von Mises, Hayek, et al. bided their time until their moment came. This moment came in the 1970s when the post-war boom petered out. They found a populariser of their beliefs – albeit in crude form – in Milton Friedman of the Chicago School and what was called monetarism. These ideas then migrated from academe via the broadsheet press and finally to the right-wing political parties at the time headed by Thatcher and Reagan.
The Austrian school believe that attempts to control capitalism through state intervention will fail and will in fact be positively counter-productive. This is because such interventions distort the price mechanism leading to misallocation of resources, inflation, and asset price bubbles. A good example of this would be the credit/property boom (2008) which was enabled by the accommodative actions of the Central Banks and Treasuries around the world, but particularly by the Bank of England and the US Federal Reserve Board. Interest rates were kept low and both heads of the two respective central banks as well as Treasury officials, in the UK’s Labour government, Gordon Brown and Edward ‘light touch regulation’ Balls in the UK, and the Fed boss Alan Greenspan in the US. Thus the natural cyclical tendencies immanent in the capitalist system were given an additional push by government monetary policy. Why? The answer is disarmingly simple: booms and bubbles (at least during the up-phase) are popular with the masses and are therefore good politics. Who can ever forget ‘the-end-of-boom-and-bust’ triumphalism of the period? However, the Austrians continued to argue that booms and busts are intrinsic to the system. One cannot exist without the other. During the boom phase of the cycle investors and consumers tend to become overconfident and make foolish investment and purchasing decisions. Prices start to rise due to the continual demand for factor inputs, growth becomes more and more febrile, banks make foolish loans and acquisitions (Northern Rock and the Royal Bank of Scotland come to mind), and then, when rises in income can no longer support rises in asset prices, the whole thing collapses. This is what happened in 2008. The bust part of the cycle then begins. All the bad investments and overspending now come to light. Companies go bust, unemployment mounts, debts are written down simply because debtors cannot pay, and all the misallocations of resources can clearly be seen with half-finished empty houses standing as the self-evident physical symbols of the manic bubble period which preceded them. Here Andrew Gamble explains:
‘’For the Austrians, the business cycle had a necessary and important function within capitalism. The crisis phase of the cycle was crucial if capitalism were to renew itself and purge itself of the false values and the misallocation of productive resources which had grown up during the boom phase. The crisis was a moment of truth, when suddenly the plans, the claims and the expectations which had been formed during the upswing were put to the test. Many of them would be found wanting, and those responsible for them would have to face the consequences. The process was not just to keep capitalism efficient; it was also necessary to keep capitalism moral. Only if agents bore full responsibility for their actions would the values of prudence, reliability and sound judgement and trust, on which capitalism relied, be upheld. The crisis purged capitalism in a double sense: both practically and morally. To many of its defenders the two were equally important. It was what gave capitalism its moral legitimacy and its practical dynamism.’’ (1)
It was argued that full recovery would not be achieved by bail-outs, Keynesian deficit spending, or by rescuing companies which were simply inefficient or did not supply consumers or investors with their preferences as demonstrated by the market price mechanism. Such policies would simply create ‘moral hazard’ a tendency for investors and consumers to carry on as usual with their losses being underwritten by the state; in this situation there was no intention or incentive for improving their business efficiency. These bailed-out entities were the economy’s living dead, kept alive on state support – zombie banks as in Europe and Japan and zombie auto companies like Fiat, Kia, and GM, or insurance companies like AIG, all of which should have been allowed to fail. With their failure more competitive efficient companies would arise in their place.
Recovery could only get underway when, as during classical depressions, prices fell, which meant that if wages and interest rates fell more slowly – if at all – then disposable income would start to increase. This being the case consumers would start to spend again and businesses start to invest. Similarly bankrupted and distressed firms would be bought out at fire–damage prices by the more efficient and larger firms with more up to date equipment. Growth now resumes given the destruction of existing capital values. The process of accumulation can restart.
What is striking about this (Austrian) theory is its similarity to Marx’s view of trade cycles, and also to those views espoused by Schumpeter. But much of both theories were formulated in an earlier phase of capitalism. But for all that the Austrian theory’s analysis of the bust is quite plausible and sophisticated.
‘’The anti-deflation policies which have been adopted (i.e., Keynesian demand management) is largely a policy of price-fixing, a policy of preventing the market from exposing capital misallocations and then liquidating them. The root causes of the crisis remain in place and the underlying problems unaddressed … The economy cannot realistically be expected to rectify itself if the market is not allowed to liquidate capital misallocations. The state has erected a protective fence around the most dislocated sectors of the economy (house prices for example) trying to keep market forces outside. As long as it lasts no true recovery is possible.’’ (2)
Summing up the Austrian view, capitalism is intrinsically cyclical. The Growth periods tend to run out of control resulting in bad investments and resource misallocation. This process is fed by easy credit and excess liquidity. Asset price inflation rises to a level which can no longer be sustained by rises in income or further borrowing. The boom turns into a bubble and the bubble bursts. Then the whole process swings into reverse – the bust has arrived. However, the bust rectifies the situation by liquidating all the mal-investments and making way for a reconfiguration of the system on a more sustainable and efficient basis. Capitalism restructures itself through these types of crises.
Prescriptions
Although the Austrian (and indeed Marxist) analysis of the bust is, I would argue broadly speaking correct, but the future policy prescriptions of the Hayekians seem frankly alarming. The scope and interdependence of the system is such that the notion of simply letting the bust take its course would lead to quite massive economic, political, and social dislocations on a global scale – as would have been the case had world governments simply let the coronavirus pandemic rampage through societies and run its course in 2020 – such a policy would dwarf the depression of the 1930s and 2008. In a strictly logical sense the reasonings of the Austrian school are correct, but their policy prescriptions are simply too terrible to contemplate.
‘’The Libertarians are actively promoting policies sure to bring about immediate economic hell, in the faith that punishment and suffering are the prerequisites to an economic afterlife in a better world. While in the end their philosophy of economic karma may ultimately prove correct, before accepting the remedy through collapse, other approaches should be put to the test. Economic reincarnation could take a lot longer than the Libertarians anticipate. The Renaissance did follow the fall of Rome – but only after 10 centuries.’’ (3)
So what about the alternatives?
John Maynard Keynes and his followers
Well I think we need to clear up one or two things about Lord Keynes before we start. Keynes was emphatically not a socialist, if anything he was actively hostile to socialism. He opined that: ‘’The class struggle will find me on the side of the educated bourgeoisie.’’ (4) We might legitimately enquire who, apart from Keynes himself, might be the ‘educated bourgeoisie’ exactly! Further, The Labour party is a class party, and that class is not my class. Again, How can I adopt a creed – Socialism – which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeois and intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement. It seems necessary to state this because of the widespread belief on the left that Lord Keynes was indeed some sort of (closet)-socialist. This could not be further from the truth: Keynes main aim in life was to save capitalism from itself.
His magnum opus, ‘’The General Theory of Employment Interest and Money’’ first published in 1936, represented the culmination of his earlier writings in which he elaborated what he believed to be the problem situation which had arisen in the world economy during the 1930s, and what he believed to be the solutions. But Keynesianism is not really a theory of the trade cycle, nor is it a general theory (more of which later) it is more a theory of boom/bust and possible ways out of economic depressions. The bust period in a capitalist economy generally follows a period of excess credit and hence debt-fuelled growth. This was the case during the roaring 20s with runaway credit (debt) fuelling growth until – pop went the weasel! Credit duly contracted as the defaults multiplied, and so the Roaring 20s transmuted into the depressed 30s.
‘’In 1930 the US money supply comprised currency held by the public (9%) and deposits held at commercial banks (91%). Banks used these deposits to fund their loans. When the credit that fuelled the Roaring 20s could not be repaid, the banks began to fail. When a borrower defaults it not only destroys credit, it also destroys the deposits which funded the credit. Between 1930 and 1933, 9,000 US banks failed. The corresponding destruction of deposits caused the country’s money supply to contract by a third from $46 billion in 1928 to $31 billion in 1933. As the money supply shrank the happy economic dynamic that expanding credit had made possible, went into reverse, and the global economy spiralled into catastrophe.’’ (5)
Post-crash, the problem was not excess demand but insufficient demand. This became known as debt-deflation. This is where Keynes and his co-thinkers entered the scene. With consumers and investors not spending, aggregate demand in deflationary conditions is flat, or even falling. Therefore the solution could only be increased spending by the government. This to be carried out by a mixture of monetary policy (lowering interest rates and Open Market Operations, and now Quantitative Easing – QE) and/or fiscal policy (taxation and public spending). This is of course something of an oversimplification of Keynes’ theories which were somewhat more radical than most of his enthusiasts found to their taste, but it broadly captures the gist of what he said. The increase in aggregate demand would feed through to the rest of the economy and so induce an increase in output which would be eventually self-sustaining. Governments would find it necessary therefore to run budget deficits during this period. Q.E.D.
This approach was taken up by the Roosevelt administration when it came to office in 1933. At that time unemployment in the US stood at the alarming figure of 25%. A raft of policy measures including the Works Programme Administration (WPA), National Recovery Act (NRA), Tennessee Valley Authority (TVA) Civilian Conservation Corps, were implemented. Unemployment fell to 14% by 1936, but then rose again during a new recession in 1937/38 to 20%. So the track record of Keynes policies seems patchy to say the least.
The Long Boom and its collapse 1980-2008
In our own time we have seen almost a repeat of the 1930s debacle. The long boom of 1980-2007 was floated on a sea of debt. But even this period was punctuated by blow-outs, first in the Savings and Loans episode of the 80s and 90s, then the Long-Term Capital Management collapse in the 90s, and finally the dot.com bubble in 2001. The 2008 crisis was, however, seemingly worse than these events and more global than that of the 1930s. In 2008 the whole credit/property induced boom came to a shuddering halt when the sub-prime borrowers in the US defaulted. House prices, which, had been rising by double digit percentages since the early 90s collapsed in 2006 and have been falling, apart from one or two transient minor upturns, ever since.
The same was to also happen in Iceland, Ireland the UK and Spain who had also built their policies around house-price inflation. Mortgage backed derivatives – i.e., those financial products which were based upon these repackaged dubious mortgages were parcelled up and sold as new financial products to brain-dead investors around the world after being given the triple AAA seal of approval by the ratings agencies. These derivatives were only producing a stream of income so long has the mortgagees continued to pay their instalments – when they defaulted the derivatives became worthless, the banks, who among others such as pension funds who had been purchasing these debt instruments, then found that their newly acquired ‘assets’ had turned into liabilities overnight. Many banks were effectively insolvent, and the great bank panic of 2008 spread around the world.
Governments found it necessary to bail-out these institutions in order to avoid a global meltdown. So the banks happily transferred their junk ‘assets’ onto the sovereign nations’ balance sheets courtesy of the Central Banks. Needless to say this was only the opening of the great recession of 2008/09 which in spite of its putative ‘recovery’ still drags on. The crisis was to cross the pond from the US – whose fundamental problems still seem unresolved – to Europe where the problem became more acute.
Stabilisation and low growth 2009-onwards
Since the nadir of 2008/09 there has been a stabilisation rather than what we might meaningfully call a recovery in the global economy. Growth is flat or falling in Europe, although there are very marked regional disparities, and very weak (and as I write, beginning to actually stall) in the USA, again with regional disparities. Interestingly, perhaps with all the clamour regarding austerity in the eurozone, no mention was made in the 40 or so US states – some effectively insolvent – which oversaw swingeing austerity programmes, California and Wisconsin come to mind, as does Detroit, famous for Tamla Motown and auto-vehicle production. A one time industrial city of 2 million people became a ghost town of 700,000.
Concomitant with this there were high levels of unemployment on both sides of the pond. Official figures for US unemployment, as found in the Bureau of Labor Statistics (BLS) are completely fraudulent and always have been since whole swathes of de facto unemployed have been disappeared off the register simply by definition. (The same disappearing trick was used with the core inflation figures.) The BLS gives three levels of unemployment according to how the word is defined. In fact there are six definitions ranging from U1-U6. The BLS uses U3 but the figure for U6 is double. And if the same definition were applied as used to be the case then unemployment would be almost 4 times the official account. The same jiggery-pokery is used when defining inflation. Each redefinition gives a lower figure.
Regarding this universal practise, it was the late Conservative Member of Parliament and at one time member of Mrs. Thatcher’s Cabinet, Lord Gilmour, who once said of his government’s unemployment reduction programme: ‘’Now we have reduced the unemployment figures, perhaps we can make a start on reducing unemployment.’’ I am afraid the pollution of statistics is the same for inflation, GDP growth and various other economic statistics. These statistics are not some measurements of objective facts, but simply political constructions. (6)
In passing we should become aware of a new economic development which came into being after 2008 and persists to this day. This was the genesis of the so-called ‘gig’ sometimes called ‘sharing’ economy. It should be made clear that this sector of the economy is generally very much ’off the books.’ The modern workforce has become increasingly stratified. There are well-paid jobs for a small portion with the requisite skills, but the vast majority of new employment is in the low-paid service sector, such as retail, leisure, hospitality, age-care and health-care. The sharing-economy is generally part of the informal sector but requires abundant cheap contract labourers to be available at the touch of a smartphone screen. Fulltime employees with normal benefits would make the model unworkable. This ‘gig’ or sharing economy exploits low-wage workers in a weak economic environment. This new ‘eke-onomy’ consists of individuals renting out their houses, cars, or labour make only a fraction of what they would receive in traditional full-time jobs, without any employment benefits. This is what Marx/Engels termed the industrial reserve army consisting of the unemployed and under-employed. Moreover, in the UK at least most of the workforce engaged in this low-paid, insecure drudgery are for the most part, immigrant labour, often illegal, from Romania, Spain, Portugal, Poland, the English-speaking part of Africa and even as far as China. Welcome to the ‘smart’ economy.
Keynesian policies … and debt levels
The general Keynesian response to the downturn has been a hue and cry for stimulus at all costs. Keynesian counter-cyclical policies traditionally consisted of 1. Monetary policy. This comes under the remit of the Central Bank and consists of control of interest rates and money supply. 2. Fiscal policy, which is the remit of the Treasury consisting of taxation and public expenditure. Sotto Voce It should be noted at this point that the Central Banks became the source of economic policy. This was a new departure since it meant that fiscal policy was relegated to a secondary role in economic planning. Monetary – i.e., central bank – policy now ruled the roost. The rigidly orthodox European Central Bank (ECB) – more catholic than the Pope – adopted hard-nosed monetary policies in the eurozone with alacrity, whilst the Anglo-American approach involving monetary and second-tier fiscal policies were partially adopted in the UK and more rigorously in the US.* The ECB put the weaker economies in the eurozone – Greece, Spain, Portugal, Ireland, Italy, Latvia – through the wringer of a grinding depression. No stimulus policies were undertaken, since it is argued this would pile more debt onto unprecedented levels already extant. Results have, to say the least, not been exactly encouraging, particularly in the southern European periphery. This situation has received press coverage ad infinitum much of it justified, but much incredibly biased and ignorant, but hey, this is the white noise of democracy in action.
Given that the eurozone crisis has received saturation coverage we will move on to the UK. Here we have a bizarre mismatch of policies: a loose monetary policy with the Bank of England lowering the base rate to 0.5% and engaging in money printing – otherwise known as Quantitative Easing – and a tight fiscal policy with the Treasury cutting back on public spending. The result? The worst of both worlds, inflation, and – good old 1970s stagflation.
The poster child for the Keynesians was the United States which threw everything but the kitchen sink at the problem in both fiscal and monetary terms. This produced some low growth and a slight fall in unemployment, albeit from an extremely high level, and recently reversed, but each additional stimulus has had less of an impact than the one preceding it. A sort of diminishing returns was to set in, whereby more and more of the ‘fix’ is needed to get any sort of result.
‘’ … in the 1970s the increase in GDP was about 60 cents for every dollar of increased debt. By the early 2000s this had decreased to close to 20% of GDP growth for every new dollar of debt.’’ (7)
The Federal Reserve had already initiated 2 rounds of QE injecting literally trillions of $s into the economy. In addition it lowered interest rates to 0.25% – zero to all intents and purposes. The Fed’s purchase of paper assets was facilitated with the printing of paper monies. These paper assets consisted of US Treasury bonds and junk securities from government sponsored enterprises such as Freddie Mac and Fanny Mae, the two government agencies whose remit was to issue mortgages to prospective US homebuyers. This meant that the assets purchased by the Fed were nothing more than debt, unredeemable debt at that. This is a weird situation where the Fed was buying US bonds issued by the Treasury department so that the US Federal government could pay its current bills. And where did the Fed get its money from? Out of thin air apparently, it simply printed the stuff! When the stage is reached where governments have to pay their current expenditures by printing money then the alarm bells should start ringing. An idea of the monies involved was described as follows:
‘’Before the first round of QE began, the Fed held roughly $900 billion of assets. When it ended on March 31, 2010 the Fed’s balance sheet had more than doubled to $2.3 trillion. There is no precedent for fiat money creation on this scale in the US during peacetime.’’(8)
Suffice it to say that money printing has continued and massively expanded to the present day 2020. Increasing the supply of paper money in the economy in the absence of demand for it can only produce one result – inflation, albeit after a time lag. (But this works on the assumption that the velocity of circulation of such monies remains constant. If the circulation falls to zero, then there will be no inflation. Deflation is more likely if the money supply does not reach the real economy. If the rate of money circulation does not alter, we can expect inflation to appear.) It will be objected, however, that the US rate of inflation was at the time of the 2008 episode only 2.3%. True. But bear in mind that both food and fuel price increases are left out of the calculation in what is termed US ‘core inflation’; another egregious example of officialdom’s statistical sleight of hand. Were those price rises added in then at the very least the US inflation figures would almost certainly double. Moreover, the global effects of the Fed’s policies has been to export this inflation around the world as a mass of greenbacks flew out of the US looking for more favourable investment outlets. The global supply of these Eurodollars (i.e., US$s circulating outside of the US) had ballooned, and this led to an inflationary impact globally as food and commodity prices (notably oil) had spiked. This in turn led to food riots and political disturbances throughout the world, particularly in the Middle East. A sort of unforeseen justice was done, however, when higher oil prices hit the price of gasoline in the US – a boomerang effect. The inflationary effect of the Fed’s money printing also meant that local currencies were put under pressure. When the $ tsunami entered a country their own currency was subject to an upward revaluation, which meant a higher exchange rate. They were therefore faced with two choices: one, do nothing and let their export markets contract since their currency was now more expensive, or two, maintain the value of their currency against the US$ by purchases of more of these dollars with their own currency. This would mean that their own money supply would expand and become inflated. Thus US inflation had become global inflation. Yes, devaluation is a great way to start a currency war.
As far as fiscal policy goes the US has consistently run budget deficits since the 1990s when it actually recorded a small surplus. The cost of the government takeover of Fannie Mae and Freddie Mac, the cost of ongoing wars in the middle east, the cost of bailouts to various financial institutions, the cost of fiscal transfers to cash-strapped states and various stimulus programmes has raised the US budget deficit (2008 figures) to $15.5 trillion, which given that the Gross Domestic Product of the US as of May 2012 was $15.6 trillion, makes the ratio close to 100%. Even before the economic crisis, the U.S. debt grew 50% between 2000-2007, ballooning from $6-$9 trillion. Now the implications of this are indeed sobering.
According to the authors Reinhart and Rogoff when debt to GDP ratio reaches 90% this will constitute a drag on future growth. And bear in mind that this figure of debt-to-GDP has risen to 107% in 2020. Longer term implications of America’s chronic debt problem are manifest. Sure the Fed can print unlimited monies, but it can’t guarantee that these greenbacks will have any value.
Over the next 20 years, the Social Security Trust Fund won’t have enough funds to cover the retirement benefits promised to Baby Boomers. That means higher taxes since the high U.S. debt rules out further loans from other countries. Unfortunately, it’s most likely that these benefits will be curtailed, either to retirees younger than 70, or to those who are high income and therefore aren’t as dependent on Social Security payments to fund their retirement.
Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, anticipation of this lower demand puts downward pressure on the dollar. That’s because dollars, and dollar-denominated Treasury Securities, may become less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand.
The bottom line is that the large Federal debt is like driving with the emergency brake on, further slowing the U.S. economy.
Now if we add in private debt to the equation – i.e., the debts of household sector corporate sector, business sector, non-corporate businesses, State, and local government – then the debt soars to something like $50 trillion, or 363% of GDP. Then of course there is the chronic deficit on current account which adds a further dimension to the problem, and all of these seemingly intractable processes are still ongoing but hey, let’s not labour the point.
The seriousness of the situation is only matched by the complacency of the US authorities who seem to think they can go on raising the budget borrowing ceiling and that overseas investors will simply keep on buying their Treasury bonds forever. If ever there was a definition of unsustainable this is it.
In fact the structural problems in the US economy could well be fatal if these colossal debt levels are not reined in or simply stabilised. The US is being kept afloat by their ownership of the global reserve currency and the willingness (for now) of investors, mainly China, Japan and the oil-rich states in the middle-east to keep purchasing US Treasury paper – paper assets of dubious value and paltry yields. Overseas investors are aware of this situation and have begun to lower their exposure to the US$s and dollar denominated assets by diversifying into other assets and have also started to trade in their own currencies rather than the dollar. Straws in the wind perhaps, but indicative of future trends.
Taken by themselves Keynesian demand-side policies of stimulating the economy hardly begin to grapple with the problem. This is because deeper problems are on the supply-side not the demand-side of the economy. They can be classified as follows. Deindustrialisation as the manufacturing base is hollowed out or emigrates to cheaper venues; ageing populations; rising energy costs and scarcity; saturation of markets; lack of leadership at the political level; finance running amok; the ability to create paper money and assets without limit; an inadequately trained workforce; skills and investment deficit; and structural unemployment brought about by new technologies. And to crown it all there is the dreaded ‘Triffin Paradox’ to be factored into the equation, but this would take another article. Moreover, I could also have added in the issue of climate change but didn’t want to depress my readers unduly.
Keynesianism is fixated on the demand-side. But in a world beset by the sort of supply-side problems listed above traditional demand-management policies used since the war will not be effective. It is also worth adding that both Germany and Japan, where the wartime devastation was manifest both recovered strongly without Keynesian demand management. This actually serves to validate the Austrian and Marxist theory that upturns and booms in a capitalist economy are the result of the destruction of existing capital values. Japan and Germany roared ahead because their own industries and infrastructure was decimated, and they had to install the most modern up to date capital equipment and technologies and again start from scratch. Economies which start from a low base tend to have extremely high rates of growth.
I did mention earlier that Keynes’ General Theory is in fact not a general theory at all but a special theory. Such policies may have been appropriate for the post-war period with the usual cyclical movements of the trade cycle, but dare I say, this time it’s different. What we are now confronted with is a systemic global crisis of capitalism. In the present situation Keynesian policies – which are commonly understood and promulgated by his epigones – are unlikely to have the desired effect for the following reasons.
‘’Keynes’ theory that government spending could stimulate aggregate demand turns out to be one that works in limited conditions only, making it more of a special theory than a general theory which he had claimed. Stimulus programmes work better in the short run than in the long run. Stimulus works better in a liquidity crisis than in an insolvency crisis, and better in a mild recession than a severe one. Stimulus also works better for economies that have entered recessions with relatively low levels of debt at the outset … None of these favourable conditions for Keynesian stimulus was present in the United States in 2009.’’ (9)
It has been calculated that growth would have to be at the rate of 6% per annum which when inflation is factored in reduces to actual growth of 2% to make any inroads into the huge debts. This seems very, very unlikely, although this is what the US authorities will attempt to do.
One final point with regard to Keynesian policies: They are often thought of as an alternative to austerity, when in fact they are simply austerity by other means. It is an open secret, though never admitted, that both the Fed and the Bank of England are attempting to monetize the debt levels in both countries. This entails keeping inflation one or more jumps ahead of wages, pensions, benefits, and interest rates. This inflation is engineered by the Central Bank which devalues the currency – supposedly to make exports more ‘competitive’ and printing money through QE. Devaluation leads to an increase in import prices which will tend to feed through the rest of the economy causing domestic inflation. The time-honoured claim made by the then British Prime Minister, Harold Wilson, in 1967 that the proposed 17% devaluation of the £ ‘would not affect the pound in your pocket’ was simply a barefaced lie. When a country devalues its currency it makes itself poorer (‘competitive’ is of course the preferred description). That is its whole raison d’être, and in this respect, it is no different from a policy of deflation.
Thus the disposable income of the mass of the population is effectively pushed down as prices rise, and the most acutely affected will be the poorer sections of the community or anyone who keeps their assets in cash. The more opulent, however, will be able to switch into stronger currencies, and physical assets such as precious metals, property, L’Objets d’Art which will appreciate in price. Inflation will help debtors since their debts will be effectively amortized, i.e. grow less as inflation lowers the magnitude of the debt. Of course the principal debtor is the government.
Forcing down interest rates to near zero in an inflationary environment gives savers two options. Do nothing and watch their savings melt away, or just go out and blow the lot. Similarly investors will be forced into more risky investments as they see the paltry return to safer bolt holes such as gilts being eaten away by inflation. It all rather sounds like a re-run of 2002-2007 credit-fuelled growth madness. And paradoxically, because disposable income is crimped by such a policy, aggregate demand falls, and this gives another push to deflation – the law of unintended consequences.
Keynesians see the problems of past and present capitalism as purely technical. They apparently believe that capitalism can be ‘fixed’ using appropriate tools and that it would therefore be possible to have permanent semi-boom conditions. This is clearly expounded by economists such as the American Keynesian, Paul Krugman in his book Peddling Prosperity, first published in 1994. Having spent most of his life during the post-war boom, he is apparently dumbfounded that it suddenly ended in the early 1970s. He intoned that … In 1973 the magic went away. Well ‘magic’ had nothing to do with it. Capitalism was beginning to enter into a periodic systemic convulsion which is now reaching its climax.
After Keynes – What to Do?
‘’Can Capitalism survive? No I do not think it can … Can Socialism work? Of course it can.’’ (10)
On the first point Schumpeter was at that time wrong, but it is now a question which needs to be raised again. On the second point, he has to be right. But this is a political rather than a purely technical question. The present crisis will be solved sooner or later (preferably sooner) but the question is how, by whom, and for whom?
The question for socialists, or for that matter any oppositionists to the present regime, is what should the strategy be for the coming struggles with this system – a system which cannot go on in its present form for the simple reason that it needs to grow at a compound rate of 3% forever – this is not possible for both political, economic and environmental reasons. Socialism or a collapse into semi-barbarism seems to be on the agenda once again. But we shouldn’t be surprised by this; it is surely what we have been expecting since the trouble started brewing in the late 60s. After all capitalism moves in huge cyclical convulsions, and this is one of them.
This is a colossal question and I can only allude to possible areas of political action. The first thing to realise is that the historical window for a social-democratic Keynesian solution to the crisis is now closed. It was only made possible by a specific conjuncture of political and economic circumstances. The Thatcher-Reagan settlement and globalization marked the death-knell of the Keynes/Beveridge consensus. (11) Does this mean that socialists should not support a policy of reform within the system? Not at all. But this support must perforce have in view the objective of forcing a paradigm shift away from what has been a trade unionist approach of simply gaining and defending reforms – to a struggle for real political and economic power.
The programme of the liberal-left – the type of journalism which we see in the Guardian and Independent and Labour party publications – actually advocates reform of a system which is beyond reform. It should also be clearly understood that such reforms as advocated by most of the liberal-left such as public spending on work creation programmes, investment in green technology, a national investment bank will only provide a temporary fix, and may well have negative downsides, such as inflation.
‘’A short-run revival of growth, as opposed to proliferating distress, can … buy time for longer term solutions to the transition to be worked out. But bought time is only useful if it is put to good use.’’ (12)
Keynesian reform will not be a long-term solution, but it can alter the political balance of power and shift the argument in favour of the 99%. The politicisation of the mass of ordinary folk can begin with such an approach. Socialists, however, need to go much further than the type of Keynesian stimulus programme as advocated by Hutton, Krugman, Elliott, et al. Such a programme might consist of the following set of workable policies.
- Public works programmes to reduce unemployment. Or full maintenance for the unemployed.
- Nationalization of all deposit taking institutions and the setting up of a national bank.
- Strict rules on credit creation and the Shadow banking system.
- More transparency and an end to over-the-counter (OTC) trading.
- Closure of tax havens. Stop tax avoidance scams such as Transfer Pricing.
- Withdrawal from overseas conflicts and NATO.
- Harmonisation of corporate tax rates within the EU.
- End of the global reserve status of the US dollar.
- Indexation of wages, pensions, benefits, interest rates to inflation
- A move away from indirect to direct taxation, and higher tax rates for the upper quintile of the population.
- Tax harmonisation in Europe to prevent tax competition and the race to the bottom.
These represent the economic demands. But capitalism also works at a political micro-level. The power relations in the work-place are such that employees and consumers have no say in how the business is run, by whom and for whom. Shareholder value is all that matters. This should be replaced by a stakeholder approach where all the interest groups have a say in the running of the organization.
Of course there is no possibility that such demands as these will be met, there is a war going on after all, and at the moment the class enemy have the power and the veto, notwithstanding the democratic will of the people. Moreover, some of these questions can only be raised at regional and/or global levels. This opens up several additional cans of worms. There is the seemingly intractable issue of Europe and the euro? Reversion to national currencies (as advocated by the Guardian’s economics team) may only lead to devaluation and trade and currency wars. Then there are global currency and trade issues: What replaces the dollar as the basis for a global currency? The IMFs Special Drawing Rights? A new gold standard? Or Keynes’ idea of a global currency – Bancor – to replace national currencies, in international trade. Then there is the massive question of climate change and the massive ecological damage and negative externalities which is the corollary of consumer capitalism. The problem we face is that politics are national, but capitalism and economics are global. But reforms of this type can obviously only be carried out at international level (13) but the starting place must be national. Co-ordinated global action is not going to happen any time soon, but regional action, whether in Europe, North and Latin America as well as the ASEAN bloc is a possibility – in fact it is the only option for supra-national policy making at the present time.
The task seems truly Herculean, the point is, however, that these issues must sooner or later (preferably sooner) be raised. They cannot be evaded. We do not choose history, history chooses us. And this is the labour of Hercules which history has bequeathed.
‘’An alternative (to capitalism – FL) will have to be found. And it is here that the emergence of a global co-revolutionary movement becomes critical not only to stemming the tide of self-destructive capitalistic behaviour … but also to our re-organizing ourselves and beginning to build new collective organizational forms, knowledge banks and mental conceptions, new technologies and systems of production and consumption, all the while experimenting with new institutional arrangements, new forms of social and natural relations, and with the redesign of an increasingly urbanized daily life …
While capital has provided us with an abundant means with which to approach the task of anti-capitalist transition, the capitalists, and their hangers on will do all in their power to prevent such a transition no matter how imperative the circumstances may be. But the task of transition lies with us not the plutocrats. As Shakespeare once advised: ‘’The fault … is not in our stars, that in ourselves that we are underlings.’ Right now, as Warren Buffet asserts his class is winning (the class war) our immediate task is to prove him wrong.’’ (14).
NOTES
(1) Andrew Gamble – The Spectre at the Feast.
(2) Detlev Schlichter – Paper Money Collapse.
(3) Richard Duncan – The New Depression p.105
( 4) JMK – Essays in Persuasion – 1925 – Am I a Liberal, A short view of Russia. Ibid
(5) Richard Duncan -The New Depression – p.121
(6) In this connection see ChrisMartenson.com Crash Course, Fuzzy Numbers and John Williams Shadow Government Statistics – passim.
(7) Foster and Magdoff – The Great Financial Crisis – p.49
(8) Richard Duncan Ibid.
(9) James Rickards – Currency Wars –pp.186/187 – My emphasis FL
(10) Joseph Alois Schumpeter – Capitalism, Socialism and Democracy – 1943
(11) William Henry Beveridge, 1st Baron Beveridge, KCB was a British economist and Liberal politician who was a progressive and social reformer. His 1942 report Social Insurance and Allied Services served as the basis for the
post-World War II welfare state put in place by the Labour government elected in 1945
(12) David Harvey -The Enigma of Capital– p.278
(13) I have since revised this view and would argue that that starting place for the sweeping reforms which are necessary at the global world system must include and start at the national level. This is not the EU we signed up to in 1976, and there comes a time in politics where it is judicious to give up flogging a dead horse. A progressive Labour government under Corbyn would not have been allowed by EU law to implement its economic reforms, cancel Trident, leave, or even modify its NATO membership. Democracy is impossible without some measure of sovereignty, and nations must get control of their own foreign and economic policies since if they don’t the globalisers and Bilderbergers will and have done
(14) David Harvey, op.cit
*The Federal Reserve Act of 1977 modified the original act establishing the Federal Reserve in 1913 and clarified the roles of the Board of Governors. The Federal Reserve has two mandates: maintaining maximum employment and maintaining stable prices and moderate long-term interest rates. Congress explicitly stated the Fed’s goals should be “maximum employment, stable prices, and moderate long-term interest rates. It is these goals that have come to be known as the Fed’s “dual mandate’’. All of which was enabled to act in both monetary and stimulus capacities.
Francis Lee
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