Global Post-Crisis
Economic Outlook
By
Henry C.K. Liu
Part I: Crisis of Wealth Destruction
This article appeared on AToL
on April 13, 2010.
An excerpt also appeared on the website of New
Deal 2.0, a project of the Roosevelt Institute.
The financial crisis that first broke out in the US
around the summer of 2007 and crested around the autumn of 2008 had
destroyed
$34.4 trillion of wealth globally by March 2009 when the equity markets
hit
their lowest points. On October
31, 2007, the total market value of publicly-traded
companies around
the world reached a high of $63 trillion. A year and four months
later,
by early March 2009, the value had dropped more than half to $28.6
trillion.
The lost wealth, $34.4 trillion, is more than the 2008 annual gross
domestic product
(GDP) of the US,
the European Union and Japan
combined. This wealth deficit effect would take at least a decade to
replenish
even if these advanced economies were to grow at mid single digit rate
after
inflation and only if no double dip materializes in the markets.
At an optimistic componded annual growth rate of 5%, it would take over
10 years to
replenish the lost wealth in the US economy.
In the US
where the crisis originated in mid-2007 after two decades of monetary
excess
that encouraged serial debt bubbles, the NYSE Euronext (US) market
capitalization
was $16.6 trillion in June 2007, more than concurrent US GDP of $13.8
trillion.
The market cap fell by almost half to $7.9 trillion by March 2009. US
households lost almost $8 trillion of wealth in the stock market on top
of the
$6 trillion loss in the market value of their homes. The total wealth
loss of
$14 trillion by US households in 2009 was equal to the entire 2008 US
GDP.
As the financial crisis broke out first in the US
in July 2007, world market capitalization took some time to feel the
full
impact of contagion radiating from New York
which did not register fully globally until after October 2007. In 2008
alone,
market capitalization in EAME (Europe – Africa
– Middle East) economies lost $10 trillion and
Asian
shares lost around $9.6 trillion. Government Bailouts,
Stimulus Packages and Jobless Recovery
As a result of over $20 trillion of government bailout/stimulus
commitments/spending that began in 2008 worldwide, the critically
impaired
global equity markets finally began to show tenuous signs of
stabilization only
two years later by the end of 2009. Yet total world market
capitalization was
still only $46.6 trillion by the end of January 2010, $16.4 trillion
below its
peak in October 2007. The amount of wealth lost worldwide in 2009 still
exceeded 2009 US GDP of $14.2 trillion by $2.2 trillion. The NYSE
Euronext (US)
market capitalization was $12.2 trillion in January 2010, recovering
from its
low at $7.9 trillion in March 2009, but still $4.4 trillion below its
peak at
$16.6 trillion in June 2007. US
GDP in first quarter 2009 fell 6.3% annualized rate while fourth
quarter of
2009 surged 5.7% mostly as a result of public sector spending equaling
over 60%
of annual GDP. The US
government bailout and stimulus package to respond to the financial
crisis
added up to $9.7 trillion, enough to pay off more than 90% of the
nation’s home
mortgages, calculated at $10.5 trillion by the Federal Reserve. Yet
home
foreclosure rate continued to climb because only distressed financial
institutions were bailed out, but not distressed homeowners. Take away
public
sector spending, US GDP would fall by over 50%. This is the reason why
no exit
strategy can be expected to be implemented soon in the US.
It took $20 trillion of public funds over a period of two
and a half years to lift the total world market capitalization of
listed
companies by $16.4 trillion. This means some $3.6 trillion, or 17.5%,
had been
burned up by transmission friction. Government intervention failed to
produce a
dollar-for-dollar break-even impact on battered markets, let alone
generating
any multiplier effect which in normal time could be expected to
generate a
multiplying effect of between 9 and 11 times. In the mean time, the
real global
economy, detached from the equity markets, with the exception of China’s,
continues to slide downward, with rising unemployment and
underemployment.
This massive government injection of new money managed to stabilize
world equity markets by January 2010, but only at 73.5% of its peak
value in
October 2007. Still it left the credit markets around the world
dangerously
anemic and the real economy operating on intensive care and life
support
measures from government. This is because the bailout and stimulus
money failed
to land on the demand side of the economy which has been plagued by
overcapacity fueled by inadequate workers income masked by excessive
debt, and
by a drastic reversal of the wealth effect on consumer demand from the
bursting
of the debt bubble. The burst of the debt bubble had destroyed the
wealth it
buoyed, but it left the debt that had fueled the
bubble
standing as liability in the economy.
Much of the new government money came from adding to the
national debt, for which taxpayers would still have to pay back in
future
years. This money went to bail out distressed banks and financial
institutions
which used it to profit from global “carry trade” speculation, as hot
money
that exploited interest rate arbitrage trades between economies. The
toxic
debts have remained in the global economy at face value, having only
been
transformed from private debts to public debts to prevent total
collapse of the
private sector. The debt bubble has been turned into a dense debt black
hole of
intense financial gravity the traps all lights from appearing at the
end of the
recovery tunnel.
Much criticism by mainstream economists in the US
has been focused on the controversial bailout of “too-big-to-fail”
financial
institutions that have continued to effectively resist critically
needed
regulatory reform by holding the seriously impaired economy hostage.
Some
critics have complained that government stimulus packages are too small
for the
task at hand. Only a few lonely voices have focused on public spending
being
directed at wrong targets. Yet such massive public spending has left
many
economies around the world with looming sovereign debt crises. The Critical Issue of
Jobs
The Labor Department reported on April 1 that the economy gained
162,000
jobs in March 2010, compared to a revised reading of a 14,000 job loss
in
February. That makes March only the third month of gains since the
recession
began. And a gain of 184,000 jobs had been forecasted for March. But
despite
missing forecasts, the March numbers were generally not viewed as
disappointing
by economists, because revisions in January and February readings added
a
combined 62,000 additional jobs. This is viewed as good news overall
for an
economy that has suffered a net loss of 8.2 million jobs since the
start of
2008, a month after the official start of the Great Recession. This
sentiment
shows how weak expectation is among most forecasters.The unemployment rate remains stubbornly
high, holding steady at 9.7%, matching mainstream economist
expectations.
President Obama immediately trumpeted the jobs report on
April 2, asserting that the employment figures are signs that the
government stimulus
package implemented a year ago has reversed the loss of about 700,000
jobs a
month that was taking place at that time. Ironically, this political
spin
underscores that even the mild improvement in jobs creation may be
reversed as
soon as the government’s stimulus program runs out, or when the central
bank exits
from its massive intervention in the market.
The President made his claim at a specially selected company
in Charlotte, North
Carolina,
that makes membranes for lithium batteries, symbolizing the dependence
on new
green technology for economic recovery. The company received a $50
million
matching grant from the $787 billion stimulus program in 2009 to expand
one
facility there and to open another elsewhere in the state.
Still, the President had to admit that “Government can’t
reverse the toll of this recession overnight, and government on its own
can’t
replace the 8 million jobs that have been lost. The true engine of job
growth
in this country has always been the private sector. What government can
do is
create the conditions ... for companies to hire again.”
Obama said many Americans are still suffering from the job
losses of the last two years. But he said despite the damage done to
the labor
market during the recession, the economy is poised to start adding the
jobs
people need. “What we can see here, at this plant, is that the worst of
the
storm is over; that brighter days are still ahead,” the President said.
In response, Republican National Committee Chairman Michael
Steele issued a statement saying the jobs gain in March reported by the
Labor
Department is not a sign of economic health. “No matter what spin the
White
House puts on these job numbers, it is unacceptable for President Obama
to
declare economic success when unemployment remains at 9.7% and a large
portion
of the job growth came from temporary boost in government employment,”
he said.
The President appeared to be putting the cart before the
horse on the issue of environmentalism and economic growth. In reality,
the
full implantation of a green economy will likely increase unemployment
from job
losses in the old energy-intensive economy. Environmentalism, like
universal health
care, is an expensive movement, and can be introduced economically only
with a
strong economy. It is foolhardy to expect environmentalism to revive a
seriously impaired economy.
The jobs report contained sobering readings for the depth of
labor market distress that has built up over the last two years. There
are 15
million workers counted as unemployed in March 2010, down 607,000 since
the
record high hit in October 2009, but still the fifth highest total on
record.
The average period of unemployment now stands at eight months, a
record-long
duration that has put severe hardship in many working families.
Almost one million more workers have become too discouraged
to continue looking for work and are no longer counted in the
unemployment rate
even as the number of discouraged job seekers fell by 200,000 since
February
2010.
The discouraging news is the job contractions which have
largely been confined to the private sector, despite strained and
shrinking
government budgets. Many local governments are beginning to be forced
to face
employment cuts to deal with developing budget shortfalls.
While private-sector employment fell sharply in the last two
years, the public-sector, civilian workforce continued growing until
mid-2008, after
which it remained essentially flat. As a result, while
private-employment rolls
are nearly 7% smaller than they were three years ago, public-employment
rolls
have grown by nearly 2%.
Boost in public-sector employment helped cushion the shock
of recession. Average wages of public employees are relatively
unaffected by
economic conditions compared to more elastic wages in the depressed
private
sector. Federal workers earned an average salary of $67,691 in 2008 for
comparable
occupations in both local governments and the private sector, according
to
Bureau of Labor Statistics data. The average pay for the same mix of
jobs in
the private sector was $60,046 in 2008, the most recent data available.
For
private sector workers above the average range but making below
$200,000, the
wage fall is much greater, along with higher unemployment rates.
Federal health, pension and other benefits are worth four
times what private workers on average enjoy. Even relatively
lower-paid
state and local government workers have higher total compensation than
private
workers in comparable jobs when the value of benefits is included.
In hailing the latest jobs news, President Obama warned that
“it will take time to achieve the strong and sustained growth that we
need.”
Larry Summers, director of the Obama White House’s National
Economic Council, told the Financial Times in a April 2 interview that
“post-bubble de-leveraging crises of the kind that the president
inherited are
a serious economic affliction that doesn’t get cured overnight … and
there is
still an enormous challenge around job creation.” Market Fundamentalism
and Democratic Fundamentalism
Market fundamentalism places unwarranted faith in the
mythical self-correcting power of unregulated markets driven solely by
the
no-holds-barred, winner-takes-all self-interest of unruly market
participants
risking other people’s money for private profit. It has also given
birth to
democratic fundamentalism, its political twin in capitalistic
democracies.
This democratic fundamentalism, which places unwarranted
faith in the wisdom of the majority popular vote on complex technical
problems
that most voters do not fully understand, has put an impossible demand
on
government to reduce the fiscal deficit while at the same time reducing
taxes
and increasing popular entitlement and defense expenditures. Democratic
fundamentalism has rendered government in capitalistic democracies
impotent in
solving the fiscal crisis created by market fundamentalism.
Political campaigns in capitalistic democracies has mutated
into a tactical propaganda war in which special interest groups with
the most
money to finance the manipulation of public opinion can exert the
strongest
influence on policy formulation, often at the expense of the common
good and
the national interest. The financial sector’s effective resistance to
critically needed regulatory reform by Congress is the latest example.
The
recent decision by the Supreme Court on constitutional protection for
corporations to freely spend on political campaigns is another example
of
democratic fundamentalism. Supreme Court
Confuses Money with Speech
Overruling two important precedents about the First
Amendment free speech rights of corporations, a bitterly divided Court
in a
recent 5-to-4 decision validated the First Amendment’s most basic free
speech
principle — that the government has no business regulating political
speech.
The dissenters said that allowing corporate money to flood the
political
marketplace would corrupt democracy.
The ruling, Citizens United v. Federal Election Commission,
No. 08-205, overruled two precedents: Austin v. Michigan Chamber of
Commerce, a
1990 decision that upheld restrictions on corporate spending to support
or
oppose political candidates, and McConnell v. Federal Election
Commission, a
2003 decision that upheld the part of the Bipartisan Campaign Reform
Act of
2002 that restricted campaign spending by corporations and unions.
The 2002 law, usually called McCain-Feingold, banned the
broadcast, cable or satellite transmission of “electioneering
communications”
paid for by corporations or labor unions from their general funds in
the 30
days before a presidential primary and in the 60 days before the
general
elections.
McCain-Feingold, as narrowed by a 2007 Supreme Court
decision, applied to communications “susceptible to no reasonable
interpretation other than as an appeal to vote for or against a
specific
candidate.”
The ruling represented a sharp doctrinal shift, and it will
have major political and practical consequences. Specialists in
campaign
finance law said they expected the decision to reshape the way
elections were
conducted. The decision will be felt most immediately in the coming
midterm
elections, given that it comes just two days after Democrats lost a
filibuster-proof majority in the Senate and as popular discontent over
government bailouts and corporate bonuses continues unabated.
President Obama called the decision “a major victory for big
oil, Wall Street banks, health insurance companies and the other
powerful
interests that marshal their power every day in Washington
to drown out the voices of everyday Americans.”
Freedom in society has a social dimension. A person’s
freedom cannot be practiced by limiting the freedom of others. The
concept of
freedom of political speech has long incorporated the concept of equal
time. One
person’s right to verbally attack another person exists only if the
right of
the attacked person to response is guaranteed. The concept of equal
time is
well established in the media during political campaigns.In that sense, the Supreme Court decision
appeared to be as logical as the sound of one hand clapping.Corporations have every right to spend their
money to promote their special political views, but it should be
required to
also pay for the equal time of the opposition’s right of free speech so
that
the lack of money will not be the cause of lost of freedom of speech. A Technical Rally is
not a Sign of Recovery
In the US,
a technical trading rally in the equity markets in spring 2010, rising
some 60%
from their lows in February of 2009, is interpreted by wishful bulls as
a
promising sign of a recovery of the financial markets. The bulls ignore
the
obvious fact that the rally has been brought on by massive government
bailouts
and stimulus packages. The technical rally still leaves asset prices at
some
25% below its pre-crisis peak in June, 2007. While bull market
cheerleaders
tout this fact as a continuing buying opportunity, objectively, it is
still difficult
to spot any credible signs of fundamental recovery.
Yet there is a price to be paid for the technical rally.
Government balance sheets worldwide are now burdened with huge amounts
of toxic
debt, many in amounts larger than their annual GDP figures. This toxic
debt,
now shifted from the private sector to the public sector, cannot be
made good
without new serial bubbles. This technical trading rally in the US
equity markets is clearly and fundamentally unsustainable and will
peter out as
soon as a promised exit strategy from government intervention is
implemented by
the Treasury to preserve and restore the private sector.
Since most corporate profit in recent years have come from
operational cost savings in the form of stagnant wages, layoffs and
artificially
low interest rates, a new massive wave of corporate failure will hit
the anemic
economy when government stimulus spending slows or when interest rates
are
raised by the Fed to deal with pending inflation of its own making. The
resultant tidal wave of corporate bankruptcies can only be avoided with
more
government bailouts to restructure dysfunction business models. Fiscal Deficits, Tax
Cuts, the National Debt and Interest Rates
Calls for raising interest rates to dampen debt-pushed
inflation are heard from nonpartisan sources. The Congressional Budget
Office
(CBO) estimate that President Obama’s proposed budget would add more
than $9.7
trillion to the national debt over the next decade, with proposed tax
cut
accounting for nearly a third of that shortfall.
The Obama fiscal deficit is expected to be $1.5 trillion in
2010, at 10.3% of GDP and a post-World War II record. It is expected to
be $1.3
trillion in 2011. But the CBO is considerably less sanguine about
future years,
predicting that deficits would never fall below 4% of GDP under Obama’s
current
and expected fiscal policies and would begin to grow rapidly after
2015. Deficits
of that magnitude would force the Treasury to continue borrowing at
prodigious
rates, sending the national debt soaring to 90% of GDP by 2020.
Interest
payments on the debt would also skyrocket by $800 billion annually over
the
same period.
The CBO report identifies Obama’s tax-cut agenda as by far
the biggest contributor to the projected budget gaps. As part of his
campaign
pledge to protect families making less than $250,000 a year from new
taxes, the
president is proposing to prevent the alternative minimum tax from
expanding to
ensnare millions of additional taxpayers through inflation induced
bracket
creep. Obama also wants to make permanent a series of temporary tax
cuts
enacted during the Bush presidency, which are scheduled to expire at
the end of
2010. Over the next 10 years, Obama tax policies are projected to
reduce
revenues and increase outlays for refundable tax credits by a total gap
of $3.0
trillion. Combined with escalating interest payments on large
cumulative fiscal
deficit, the tax cuts account for the entire increase in deficits that
would
result from Obama’s tax proposals.
Other policy expenditures, such as Obama’s health-care reform
program and a plan to dramatically expand the federal student loan
program,
would have significant effects on the budget, but these programs
generally
would be self-financed and therefore are not expected to drive deficits
higher.
They would only expand the public sector in the economy, a trend that
liberals
and progressives think is positive while neoliberals and conservatives
think is
negative.
Obama tried to convene a special bipartisan commission to develop
measures to bring deficits down to 3% of GDP. The response from
Republicans has
not been overwhelming as they do not want to share responsibility for
Obama’s
deficit. However, the CBO report shows that Obama could accomplish that
goal
simply by letting the Bush tax cuts expire at the end of 2010 to pay
for revenue
losses expected from proposed changes to the alternative minimum tax.
In March 2009, the CBO estimated that USgross debt will rise from 70.2%
of GDP in 2008 to 101% in 2012, while the economy is expected to stay
in
open-ended recession with unacceptably high unemployment at over 10%.
The US
is now one of the highest debtor nations in the world. The reason the
US,
unlike other countries, does not face prospect of default is because of
dollar
hegemony under which US debts are all denominated in dollars that the
US
Treasury can print at will. Yet such levels of public debt, if wasted
on the
supply side to exacerbate supply/demand imbalance, cannot be sustained
without
economic penalties.
Interest payments on the skyrocketing national debt will be
a serious obstacle to reducing the fiscal deficit even if interest
rates stay
low – an impossible prospect because of the endogenous monetary rule of
the
effect of rising public debt on inflation, which Milton Friedman define
as
always and everywherea monetary
phenomenon – i.e. excess supply of money. The Lesson from the
Great Depression
The Fed’s institutional perspective since the Great
Depression have been largely formed by Milton Friedman’s counterfactual
conclusion
that aggressive monetary easing after the 1929 crash could have
prevented the
Great Depression, even though the validity of this conclusion has never
been
verified by events, nor has its unintended consequences been adequately
analyzed. The caveat in Friedman’s monetary cure is that it requires a
fiscal
surplus which would be difficult if not impossible to achieve in a
depression.
Events have shown that the Great Depression was finally ended by war
production, not by Fed monetary or fiscal measures during the New Deal
era.
Yet while the laws of finance can sometimes be violated with
delayed penalty, they cannot be permanently overturned. The fact
remains that
central banks cannot repeatedly use easy money to fund serial debt
bubbles
without accumulating fatal consequences.
While undetected debt can be disguised as phantom equity
through creative accounting in structured finance, it remains as
liabilities in
the real world that needs to be reckoned with at the end of the day.
Risk can
be transferred globally system-wide to become less visible, but it
cannot be
eliminated by simply hiding it. Widely dispersed risk throughout the
financial
system will lead to an under-pricing of risk to give unsuspecting
investors a
false sense of security. In fact, thousands of small holes all over the
hull
will sink a ship faster than one big hole in one compartment that can
be
effectively sealed off. The result will be a sudden global financial
meltdown
when the massive Ponzi scheme of magical liquidity released by central
banks is
finally exposed. Two Phases of the
Great Depression
It is useful to remember that there were two phases of the
Great Depression. The first phase started with the stock market crash
in
October 1929 during Hoover’s
one-term presidency (1929-1933). It lasted 43 months, until 5 months
after
Franklin D. Roosevelt became president in 1933, with a GDP decline from
peak to
trough of 36.21%, unemployment reaching an all time high 25.36% and
severe
deflation as measured by the Consumer Price Index falling 27.17%.
In this phase of the Great Depression, central bankers
learned that deflation was more deadly to the economy than inflation
was to the
government, a fact incontrovertibly demonstrated by the rise of Fascism
in a
Germany caught in the quick sand of hyperinflation, and the subsequent
recovery
of the German economy under the National Socialist full employment
strategy
supported by sovereign credit. While the economic decline of first
phase of the
Great Depression was arrested by New Deal programs, the US
economy was far from being on any recovery track by 1937, four years of
Roosevelt
came into office.
The second phase of the Great Depression began in 1937
during the New Deal era after the Fed doubled bank reserve requirements
in 1936
to ward off anticipated inflation. The economic contraction of this
phase
lasted 13 months, until 1938, with a decline in GDP of 10.04%,
unemployment
reaching 20% and deflation moderating as measured by the CPI falling
only 2.8%.
Still, price deflation, caused by a tight monetary policy
pushed by Treasury Secretary Henry Morganthau (in office 1933 to 1945),
aborted
the New Deal recovery even under a Keynesian fiscal policy tilt towards
deficit
financing of demand management. As Roosevelt’s
Treasury
Secretary, Morgenthau was instrumental in setting up the Works Progress
Administration and the Public Works of Art Project in the 1930’s to
moderate
unemployment. But the economy did not recover until the start of WWII. Marriner S. Eccles - Keynesian
evangelist before Kyenes
This second phase of the Great depression can be blamed on
the early policies of the Federal Reserve under Marriner S. Eccles
(November
15, 1934-January 31, 1948). Eccles, the president of tiny First
National Bank
of Ogden, Utah,
became nationally famous through his successful effort to save his bank
from
collapse in the late summer of 1931.
Eccles defused the panic of depositors outside of his bank
by announcing that his bank would stay open until all depositors were
paid. He
also instructed his tellers to count every small bill and check every
signature
to slow the prospect of his bank running out of cash. A mostly empty
armored car
carrying all First National’s puny reserves from the Federal Reserve
Bank in
Salt Lake City arrived conspicuously while Eccles announced that there
was
plenty of money left where it came from, which was true except for the
fact
that none of it belonged to First National. The crowd’s confidence in
First
National was re-established and Eccles' bank survived on a misleading
statement
that would have been considered criminally fraudulent in a vigorous
investigation.
Eccles was a quintessential frontier entrepreneur of the US
West and politically a Western Republican. Beginning with timber and
sawmill
operations, his family’s initial capital came in the form of labor and
raw
material. He learned from his father, an illiterate who immigrated from
Scotland
in 1860, that the way to remain free was to avoid becoming indebted to
the
Northeastern banks, which were in turn much indebted to British
capital. Among
Eccles’ assets of railroads, mines, construction companies and farm
businesses
was a chain of local banks in the West.
Immersed in an atmosphere of US
populism that was critical of unregulated capitalism and Northeastern
“money
trusts”, Eccles viewed himself as an ethical capitalist who succeeded
through
his hard works and wits, free of oppression from big business trusts
and
government interference.
A Mormon polygamist, the elder Eccles had two wives and 21
children, which provided him with considerable human capital in the
labor-short
West. The young Eccles, at age 22 and with only a high-school
education, had to
assume the responsibilities of his father when the latter died
suddenly. The
Eccles construction company built the gigantic Boulder Dam, begun in
1931 and
completed in 1936, renamed from Hoover Dam in the midst of the
Depression and
re-renamed Hoover Dam in 1941.
The market collapse of 1929 caught the inner-directed Eccles
in a state of bewilderment and despair. Through eclectic reading based
on
common sense, he came to a startling awareness: that despite his
father's
conservative Scottish teachings on the importance of saving,
individuals and
companies and even banks, ever optimistic in their own future, tended
to
contribute to aggregate supply expansion to end up with overcapacity
through
excessive savings for investment.
It was obvious to Eccles that the problem of the 1930s was
that too much money had been channeled into savings and too little into
spending.
This new awareness, albeit not early enough to save him from early
policy error
made in the first two years as Fed Chairman, like Saint
Paul’s vision on the way to Damascus,
led Eccles to a radical conclusion that contradicted all that his
conservative
father had taught him.
From direct experience, Eccles realized that bankers like
himself, by doing what seemed sound on an individual basis, by calling
in loans
and refusing new lending in hard times, only contributed to the
financial
crisis. He saw from direct experience the evidence of market failure.
He
concluded that to get out of the depression, government intervention,
something
he had been taught was evil, was necessary to place purchasing power in
the
hands of the public which, together with the economy and the financial
system,
was in dire need of it. In the industrial age, the mal-distribution
(excessively unequal) of income and the excessive savings for capital
investment always lead to the masses exhausting their purchasing power,
unable
to sustain the benefits of mass production that such savings brought.
Mass consumption is required by mass production. But mass
consumption requires a fair distribution of new wealth as it is
currently
produced (not accumulated wealth) to provide mass purchasing power. By
denying
the masses necessary purchasing power, capital denies itself of the
very demand
that would justify its investment in new production. Credit can extend
purchasing power but only until the credit runs out, which would soon
occur
without the support of adequate income.
Eccles’ epiphany was his realization that Calvinist thrifty
individualism does not work in a modern industrial economy. Eccles
rejected the
view of his fellow bankers that depressions are natural phenomena and
that in
the long run the destruction they wreak are healthy and that government
intervention only postpones the needed elimination of the weak and
unfit,
thereby in the long run weakening the whole system through the support
for the
survival of the unfit.
Eccles pragmatically saw that money is not neutral, and it
has an economic function independent of ownership. Money serves a
social
purpose if it circulates widely through transactions and investments,
and is
socially harmful if it is hoarded in idle savings, no matter who owns
it.
Liquidity is the only measure of the usefulness of money. The penchant
for
capital preservation on the part of those who have surplus money has a
natural
tendency to reduce liquidity in times of deflation and economic
slowdown.
The solution is to start the money flowing again by
directing the money not toward those who already have a surplus of it
in
relation to their consumptive needs, but to those who have not enough.
Giving
more money to those who already have too much would take more money out
of
circulation into idle savings and prolong the depression.
The solution is to give money to the most needy, since they will
spend it immediately. The only institution that can do this transfer of
money
for the good of the system is the federal government, which can issue
or borrow
money backed by the full faith and credit of the nation, and put it in
the
hands of the masses, who would spend it immediately, thus creating
needed
demand. Transfer of money through employment is not the same of
transfer of
wealth. Deficit financing of fiscal expenditure is the only way to
inject money
and improve liquidity in a stalled economy. Thus Eccles promoted a
limited war
on poverty and unemployment, not on moral but on utilitarian grounds.
Now, the interesting thing is, Eccles, who never attended
university or studied economics formally, articulated his pragmatic
conclusions
in speeches a good three years before Keynes wrote his epoch-making The
General Theory of Employment, Interest, and Money (1936). John
Galbraith in
his Money: Whence It Came, Where It Went (1975) explained: “The
effect
of The General Theory was to legitimize ideas that were in
circulation.”
With scientific logic and mathematic precision, Keynes made crackpot
ideas like
those promoted by Eccles respectable in learned circles, even though
Keynes
himself was considered a crackpot by New York Fed president Benjamin
Strong as
late as 1927.
In one single testimony in 1933, Eccles in his
salt-of-the-earth manner convinced an eager US Congress of his new
economic
principle and outlined a specific agenda for how the federal government
could
save the economy by spending more money on unemployment relief, public
works,
agricultural allotment, farm-mortgage refinancing, settlement of
foreign war debts,
etc.
Eccles also proposed structural systemic reform for
achieving long-term stability: federal insurance for bank deposits,
minimum
wage standards, compulsory retirement pension schemes, in fact, the
core
program that came to be known as the New Deal.
Eccles also helped launched the era of liberal credits,
through government guarantee mortgages and interest subsidies, making
middle-class and low-income home ownership a reality. It was not a plan
to do
away with capitalism as much as it was to save capitalism from itself.
Eccles’
plan was to give the masses high income on which liberal credits can
finance a
nation of homeowners. It was fundamentally different from the
neoliberal
program of depressing worker income through cross-border wage arbitrage
while
financing homeownership with subprime mortgages.
Eccles also rescued the Federal Reserve System from
institutional disgrace. For this, the Fed building in Washington
has since been named after him. The evolution of political economy
models in
the early 1930s, a crucial period of change in the supervision and
regulation
of the financial sector, can be clearly seen in the opposing policies
of the Hoover
and Roosevelt administrations. It resulted in a
change
of focus in the Federal Reserve Board from orthodox sound money
initiatives to
a heterodox Keynesian outlook, which was reversed by the monetarism of
Milton
Friedman. Under Eccles, the push toward centralizing the monetary
powers of the
Federal Reserve System at the Board, away from the regional Federal
Reserve
Banks, was implemented.
With support from Roosevelt, despite bitter opposition from
big money center banks, Eccles personally designed the legislation that
reformed the Federal Reserve System, the central bank of the United
States
founded by Congress in 1913 (Glass-Owen Federal Reserve Act), to
provide the
nation with a safer, more flexible, and more stable monetary and
financial/banking system. An important founding objective of the
original
Federal Reserve System had been to fight inflation by controlling the
money
supply through setting the short-term interest rate, known as the Fed
Funds
Rate (FFR), and bank reserve ratios. By 1915, the Fed had regulatory
control
over half of the nation's banking capital and by 1928 about 80 percent.
The Banking Act of 1935 designed by Eccles modified the
Federal Reserve Act by stripping the 12 district Federal Reserve Banks
of their
autonomous privileges and veto powers and concentrated monetary policy
power in
the seven-member Board of Governors in Washington.
Eccles served as chairman for 14 years while he continued to function
as an
inner-circle policy maker in the White House. The Fed under Eccles had
no
pretension of political independence. Galbraith described the Fed under
Eccles
as “the center of Keynesian evangelism in Washington”.
Morgenthau and the Bretton
Woods Conference
To finance World War II, Morgenthau initiated an elaborate
marketing system for war bonds. He arranged unlimited Federal Reserve
support
for Treasury borrowing to allow it to stand ready to buy all war bonds
not
bought by the public at a pre-agreed yield to keep interest rates low.
The War
Bond program raised $185 billion at below market interest rates to
finance the
cost of the war.
Morgenthau made his most significant contribution as
Chairman of the Bretton Woods Conference in New
Hampshire,
in 1944. This Conference, the keystone of postwar international finance
architecture, established the International Monetary Fund (IMF) and the
International Bank for Reconstruction and Development (World Bank) and
pegged
all international currencies to the dollar at fixed rated worked out
between
central banks. The dollar was in turn pegged to gold at $35 per ounce. US
citizens were forbidden by law to own gold or to speculate on its
monetary
value. Morgenthau resigned shortly after the accession of Truman to the
presidency. The Bretton Woods monetary regime collapsed in 1971 when
President
Nixon suspended the dollar from gold.
The economy finally recovered from heavy war spending in 1941.
Yet a short recession took place in 1945 as war production began to
wind down
for the European theater. It lasted 8 months, with GDP declining
14.48%,
unemployment reaching 3.4% even before troops were fully discharged and
inflation of 1.69% as war-time wage-price control began to phase out.
April 5, 2010
