Archive for April, 2010

As the general election approaches in Britain, polls reveal that the economy is foremost on voters’ minds. Economic journalists tell us that the most serious slump since the 1930s has discredited the financial sector, that neo-liberalism and Thatcherite monetarism is dead and that Keynesianism is the norm again. To put it mildly, this view is grossly misleading. In truth, the bankers still rule.

Keynesianism and Monetarism
Bailing out the banks was as much a monetarist policy as a Keynesian one. Milton Freidman agreed with Keynes about the need to immediately throw money at a banking crisis. The two men differed about the long term effects of a crisis on the private sector. Freidman recommended expanding the money supply and letting capitalists do the rest. Keynes though that capitalists would be reluctant to invest, and therefore that the state must act as investor of the last resort.

What has all this got to do with the present crisis? Simply that Keynes argued for ‘investing’ one’s way out of recession, hence the need for a big stimulus; eg, state investment in infrastructure as in China today. Although Obama’s 2009 stimulus package amounted to $800bn over three years, the EU has failed to match the US in providing the prolonged stimulus that some Keynesians would have recommended. Britain’s package—largely temporary VAT reduction and a car scrappage scheme— has been proportionately smaller than that of either the US or Germany.

Indeed, what we see today is the very opposite of stimulus. Much of today’s press is filed with ‘budget hysteria’. Political parties on all sides call for major cuts in state expenditure and bicker only about the timing of such cuts. Why this change? The answer is simple. For the past three decades, the financial services sector has grown ever more powerful—and so too has the influence of ‘bankers’ economics’.

Bankers’ economics
Professional economists tend to forget that terms like ‘Keynesianism’, ‘monetarism’, ‘rational expectations’ and so forth have little purchase on bankers. Nor do bankers have much time for discussing the pros and cons of the social market or the discontents of globalisation. The main business of commercial banking is—or at least used to be—that of making prudent loans and keeping the books balanced.

Bankers worry in essence about three things. First, they are concerned about customers, particularly governments, who borrow excessively. Such customers may be unable to pay back their loans, hence leaving the bank with non-performing assets. Such borrowing may drive interest rates too high, squeezing bank profits.

Secondly, bankers worry about inflation, which erodes the real value of a bank’s assets. In this their interest are opposed to those of householders who hold debt, the value of which is comfortably eroded by mild inflation. Remember, every time a bank lends you money for, say, a mortgage, it appears on your balance sheet as a liability but on the bank’s as an asset. Bankers don’t like to see their assets inflated away.

Finally, bankers believe in a strong currency, particularly when banks borrow from international money markets in order to lend to domestic customers. ‘Leveraging’ means engaging in more borrowing; banks typically pay a risk premium to borrow more and more on the money market. The credit crunch has made borrowing more difficult. So the last thing bankers want is to incur an extra risk premium for having a weak currency.

The woes of the EU
At present, Britain and the other the core economies of the EU are emerging from the most serious downturn in the world economy since the 1930s. Under such circumstances—and much as in 1930s—to argue that EU countries must pursue ‘sound money’ is bad advice. Both monetarists and Keynesians agree that extreme monetary prudence can plunge our economy into deeper recession.

Depressed aggregate demand provides no incentive for private capitalists to invest. To raise aggregate demand, Keynes argued, the state must do what private capitalists cannot. The relevance of this argument should be obvious. A large state-led investment programme is needed to build new infrastructure and to develop alternative energy generating capacity. But no major political party in Europe dares stand up for this principle. Instead, what we are seeing is a return to bankers’ economics: low inflation, prudent public finance, strong currencies and wage compression.

The financial sector has given us the worst crisis since the Great Depression—-it now dictates the terms on which to emerge from the crisis. Balancing the budget is not the answer—rather, it is a recipe for prolonged stagnation and increased social conflict.