Modern monetary theory—pandemic edition

Mark Tansey, “Garden” (2006)

Modern Monetary Theorists are having a moment, as governments (many of them run by conservative regimes, such as Donald Trump and the Republicans in the United States) are running gigantic fiscal deficits in order to combat the economic crisis occasioned by the coronavirus pandemic.*

This time, with the $2 trillion CARES Act, the U.S. federal government has taken an additional step down the road of Modern Monetary Theory, by having the Federal Reserve buy an unlimited amount of Treasury bonds and government-backed mortgage bonds — whatever was necessary “to support smooth market functioning”—in other words, by simply creating the necessary money.

But, as Michael Hudson et al. explain, the idea that is being celebrated right now—that running government budget deficits is stabilizing instead of destabilizing—”is in many ways something quite different than the leading MMT advocates have long supported.”

Modern Monetary Theory (MMT) was developed to explain the logic of running government budget deficits to increase demand in the economy’s consumption and capital investment sectors so as to maintain full employment. But the enormous U.S. federal budget deficits from the Obama bank bailout after the 2008 crash through the Trump tax cuts and Coronavirus financial bailout have not pumped money into the economy to finance new direct investment, employment, rising wages and living standards. Instead, government money creation and Quantitative Easing have been directed to the finance, insurance and real estate (FIRE) sectors. The result is a travesty of MMT, not its original aim.

By subsidizing the financial sector and its debt overhead, this policy is deflationary instead of supporting the “real” economy. The effect has been to empower the banking sector, whose product is credit and debt creation that has taken an unproductive and indeed extractive form.

Let me back up for a moment. I’ve been an advocate of Modern Monetary Theory ever since I began to study it (at the prodding of friends [ht: br]), as can be seen in various of my blog posts. In particular, from the perspective of the Marxian critique of political economy, two formulations that represent both critiques of and alternatives to those of mainstream economics are particularly useful: government deficits and bank money.

Perhaps the best known (and, in many ways, most controversial) aspect of Modern Monetary Theory is the logic of running budget deficits. The mainstream view is that the government imposes taxes and then uses the revenues to pay for some portion of government programs. To pay for the rest of its expenditures, the state then borrows money by issuing bonds that investors can purchase (and for which they receive interest payments).** But, neoclassical economists complain, such borrowing has a big downside: budget deficits increase the demand for loans, because the government competes with all the loans that private individuals and businesses want to take on—thus leading, in the short run, to the so-called crowding-out effect and, in the long run, an increase in government debt and the potential for a government default.

Advocates of Modern Monetary Theory dispute both of these conclusions: First, they argue that governments should never have to default so long as the country has a sovereign currency, that is, so long as they issue and control the kind of money they tax and spend (so, e.g., the United States but not Greece). Second, taxes and bonds do not and indeed cannot directly pay for spending. Instead, the government creates money whenever it spends.*** Clearly, this is useful from a left-wing perspective, because it creates room for government spending on programs that benefit the working-class—including, but certainly not limited to, the much-vaunted jobs guarantee.****

The second major contention between mainstream economics and Modern Monetary Theory concerns the role of banks—in particular, the relationship between bank lending and money. As Bill Mitchell explains,

Mainstream economic theory considers banks to be institutions that take in deposits which then provides them with the funds to on-lend at a profit. Accordingly, the ability of private banks to lend is considered to be constrained by the reserves they hold.

In other words, banks are seen as financial intermediaries, funneling deposits and then (backed by reserves) allocating a multiple of such deposits to the best possible, most efficient uses.

From the perspective of Modern Monetary Theory, private banks don’t operate in this way. Instead, they create money, by making loans—and reserve balances play little if any role.

A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. The bank expands its balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank.

This is exactly the opposite of the mainstream story, with the implication that banks create loans (and therefore money) based on the profitability of making such loans, an activity that has nothing to do with the central bank’s adding more reserves to the system.

Both points—concerning the financing of government spending and endogenous bank money—are well known to anyone who has been exposed (either sympathetically or critically) to Modern Monetary Theory. In my view, they fit usefully and relatively easily into modern Marxian economics, especially in terms of both the theory of the state (e.g., government finances) and the theory of (fiat) money.

The problem, it seems to me, arises in the terms of the major complaint registered by Hudson et al.—namely, that government stimulus plans have mostly been directed to the finance, insurance and real estate (FIRE) sectors, which are considered unproductive and extractive, and not to the “real” economy, which is not.

Readers who know something about the history of economic thought will recognize that these productive/unproductive and extractive/non-extractive distinctions have a long lineage and can be traced back, first, to the French Physiocrats and, later, to Adam Smith—in other words, to the beginnings of modern mainstream economics.

Using his Tableau Économique, François Quesnay attempted to show that the proprietors and cultivators of land were the only productive members of the economy and society, as against the unproductive class composed of manufacturers and merchants. It follows that the government should promote the interests of the landowners, and not those of the other classes, which were merely parasitic. Smith took up this distinction but then redeployed it, to argue that any labor involved in the production of commodities (whether agricultural or manufacturing) was productive, and the problem was with revenues spent on unproductive labor (such as household servants and landlords). The former led to the accumulation of capital, which increased the wealth of nations, while the latter represented conspicuous consumption, which did not.

Marx criticized both formulations, arguing that the productive/unproductive distinction had to do not with what workers produced, but rather with how they produced. Within capitalism, labor was productive if it resulted in the creation of surplus-value; and, if it didn’t (such as is the case with managers and CEOs who supervise the production of goods and services, as well as all those involved in finance, insurance, and real estate), it was not. So, the Marxian distinction is focused on surplus-value and thus exploitation.

And that, it seems to me, is the major point overlooked in much of Modern Monetary Theory. FIRE is extractive in the sense that it receives a cut of the surplus created elsewhere in the economy. But so are industries outside of finance, insurance, and real estate, since the boards of directors of enterprises in those sectors extract surplus from their own workers. And those different modes of extraction occur whether or not there’s a jobs guarantee provided by the creation of money by governments or banks.

From a Marxian perspective, then, the crucial distinction—both theoretically and for public policy—is not that between FIRE and the so-called real economy, but between classes that appropriate the surplus and otherwise “share in the booty” and the class that actually produces the surplus.

Right now, in the midst of the coronavirus pandemic, the class that is working to produce the surplus and provide the commodities we need is the one that is carrying the burden—either because they have been laid off and mostly left to their own devices, without paychecks and healthcare benefits, or been forced to continue to labor under precarious and unsafe conditions.

It’s that class, the American working-class, that is suffering from the ravages of the current economic crisis precipitated by the pandemic. They’re the ones, not their employers (whether in FIRE or the “real” economy), who deserve to be bailed out.

 

*Although this is certainly not the first time Republican administrations have run fiscal deficits, and allowed the public debt to soar—as long as they’re in power. They did it under Ronald Reagan, both Bushes, and long before the pandemic with Trump’s tax cuts. The only time American conservatives seem to worry about deficits and debt is when Democrats hold the reins.

**Wealthy individuals and large corporations long ago determined they prefer to be paid to purchase government debt instead of being taxed.

***So why, then, does the government need to tax at all in Modern Monetary Theory? Best I can figure, there are two major reasons: First, taxation makes sure people in the country use the government-issued currency, because they have to pay taxes in that currency (and not, e.g., in some kind of local or digital currency). Second, taxes are one tool governments can use to control inflation. They can take an amount of money out of the economy, which keeps consumers and corporations from bidding up prices.

****But that’s clearly not a new idea. Back in 1943, Michel Kalecki argued that governments had the ability to use a spending program (e.g., through public investment or subsidizing mass consumption) to achieve full employment. But it would likely be opposed by an alliance of big business and rentier interests based on three reasons:

(i) dislike of government interference in the problem of employment as such; (ii) dislike of the direction of government spending (public investment and subsidizing consumption); (iii) dislike of the social and political changes resulting from the maintenance of full employment.

In other words, capitalists are against both the government’s usurping of their private role as masters of the economy and society and the strengthening of the working-class, for whom “the ‘sack’ would cease to play its role as a disciplinary measure.”

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Cartoon of the day

Special mention

 

Utopia and the exhaustion of the center

We’re ten years on from the events the triggered the worst crisis of capitalism since the first Great Depression (although read my caveat here) and centrists—on both sides of the Atlantic—continue to peddle an ahistorical nostalgia.

Fortunately, people aren’t buying it.

As Jack Shenker has explained in the case of Britain,

one of the most darkly humorous features of contemporary British politics (a competitive field) is the ubiquity of parliamentarians, pundits and business titans who wail and gnash at our ceaseless political tumult but appear utterly incurious about the conditions that produced it. . .

Such stalwart defenders of a certain brand of “common sense” capitalism have watched in horror as ill-mannered upstarts — on both the right and the left — build power at the fringes. But these freshly emboldened centrists pretend that the rupture has no connection to their own dogma and seem to envision the whole sorry mess as some sort of administrative error that will be swiftly tidied away once the right person, with the right branding, is restored to authority.

Much the same is true in the United States, where centrists in the Democratic Party watch in horror as the Republican Party falls in lockstep with Donald Trump and the only energy within their own party comes from the Left. All the while, they ignore their own role in creating the conditions for the crash and the fact that their technocratic promises to American young people—university or community-college education leading to a stable and prosperous worklife, the dream of a thriving middle-class democracy, the claim for capitalism’s economic and ethical superiority—lie in tatters.

As it turns out, Jürgen Habermas sounded the warning of just this eventuality back in the mid-1980s.* His argument, in a nutshell, is that western cultures had used up their utopian energies—and for good reason, because

the very forces for increasing power, from which modernity once derived its self-confidence and its utopian expectation, in actuality turn autonomy into dependence, emancipation into oppression, and reality into the irrational.

In particular, the social welfare state—based on Keynesian economic policies and democratic politics (with a social basis in independent labor unions and labor-oriented parties)—had lost “its capacity to project future possibilities for a collectively better and less endangered way of life.”

The reactions to this crisis are well known: on the Right, the rise of neoliberalism associated with Margaret Thatcher and Ronald Reagan; on the Left, the celebration of non-party social movements. And, in the center? “Those who defend the legitimacy of industrial society and the social welfare state”—such as the more conservative wing of the Social Democrats (he mentions the Mondale wing of the Democrats in the United States and the second government of François Mitterand in France)—who “have been put on the defensive.”

I would make it even sharper: the center refashioned itself in the mould of the right-wing neoliberals, at least in part to isolate and contain the criticisms from the Left, by emphasizing individual (not collective) initiative and market-based (not social or solidarity) solutions to economic and social problems. As a result, the center lost its utopian impulse and settled for a meek defense of what remained of the social welfare state.

Habermas’s view is that society has been reoriented away from the concept of labor toward that of communication, which requires a different way of “linking up with the utopian tradition.” The alternative approach would be to rethink the concept of labor in terms of class and analyze the ways in which the forces of capital that were supposed to be regulated and contained by the social welfare state were left with both the interest and means to undo those regulations. And it’s the center that put itself in the position of responding to and representing the progressive dismantling of the economic side of the social welfare state—in deregulating finance, pursuing globalization, and helping to unleash new digital technologies. The result was, not surprisingly, the growth of obscene levels of inequality, increasing precariousness for large parts of the working-class, and finally the crisis that broke out in 2008, which has led not only to economic but also political breakdown.

However, as Shenker correctly observes, “the breakdown of any political order can be both emancipatory and revanchist.” And it now falls to the Left to reharness and reinvigorate the utopian impulses and energies that the center has squandered in order to chart a path forward.

*The English-language translation of Habermas’s article, “The New Obscurity: The Crisis of the Welfare State and the Exhaustion of Utopian Energies,” was first published in Philosophy & Social Criticism. The article, with a slightly different title (“The Crisis of the Welfare State and the Exhaustion of Utopian Energies”) and translation, was reprinted in On Society and Politics: A Reader. According to a friend and colleague who is a Habermas expert [ht: db], the essay is typical of his thinking that issued from what most people still consider Habermas’s most important work, The Theory of Communicative Action. “I would characterize Communicative Action as his middle period, which follows his earlier, more Frankfurt-styled emphasis on ideology critique (especially positivism) in books like Knowledge and Human Interests and Theory and Practice. In this middle period, he moved way from negative dialectics à la Adorno and Horkheimer toward developing a positive social theory of his own, one he would say was a “reconstruction” of Marxism but I would call a “replacement,” in which he develops a theory of communicative action to avoid what he sees as productivism and economism in the Marxist tradition.” And he adds:  “I find his means of doing so, evolutionary theory, unacceptable.”

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We’re #2!

According to the Tax Justice Network, the United States ranks second in the 2018 Financial Secrecy Index. This is based on a secrecy score of 59.8, which is practically unchanged from 2015. The only country ahead of the United States is Switzerland, with a secrecy score of 76. The rise of the United States continues a long-term trend, as the country was one of the few to increase their secrecy score in the 2015 index.

The continued rise of the United States in the 2018 index comes on the back of a significant change in the U.S. share of the global market for offshore financial services. Between 2015 and 2018, the United States increased its market share by 14 percent. In total, the United States accounts for 22.3 percent of the global market in offshore financial services.

So, actually, we’re #1!

History

The United States has long been a secrecy jurisdiction or tax haven at the federal level. For example, the 1921 Revenue Act exempted interest income on bank deposits owned by non-US residents, and this was explicitly justified at the time as a measure to a attract (tax-evading) foreign capital to the United States.

Another factor influencing policy makers later on was the Vietnam War, which opened up growing external balance of payments deficits—after a long history of surpluses. The United States increasingly needed foreign loans to finance these deficits and it did so, in significant part, by a attracting the proceeds of tax evasion and other illicit foreign money. Foreigners invested in the United States for many reasons, not least the fact of the U.S. dollar being the global reserve currency—but secrecy and tax-free treatment were also key attractions.

Alongside this history of U.S. federal-level secrecy, individual U.S. states have been hosting the formation of secretive shell companies—especially as several states (such as Delaware, Wyoming, and Nevada) have engaged in a race to the bottom to outbid one other in offering ever more egregious secrecy facilities.

Here is how it works. A wealthy Ukrainian, say, sets up a Delaware shell company using a local company forma on agent. That Delaware agent will provide nominee officers and directors (typically lawyers) to serve as fronts for the real owners, and their details and photocopies of their passports can be made public but that gets you no closer to who the genuine Ukrainian owner of that company is: if the nominees are lawyers they are bound by attorney-client privilege not to reveal the information (if they even have it: the owner of that shell company may be another secretive shell company or trust somewhere else). The company can run millions through its bank account but nobody—whether domestic or foreign law enforcement—can crack through that form of secrecy in any efficient or effective way.

 

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Laughter is the best medicine

Sometimes we just have to sit back and laugh. Or, we would, if the consequences were not so serious.

I’ve been reading and watching the presentations (and ensuing discussions) at the Rethinking Macroeconomic Policy conference recently organized by the Peterson Institute for International Economics.

Quite a spectacle it appears to have been, with an opening paper by famous mainstream macroeconomists Olivier Blanchard and Larry Summers and a closing session—a “fireside chat” without the fire—with the very same doyens of the field.

The basic question of the conference was: does contemporary macroeconomics, in the wake of the Second Great Depression, require a few reforms or does it need a wholesale revolution? Blanchard lined up in the reform camp, with Summers calling for a revolution—with the added spice of Adam Posen referring to himself as Trotsky to Summers’s Lenin.

Most people would think it’s about time. They know that mainstream macroeconomics failed spectacularly in recent years: It wasn’t able to predict the onset of the crash of 2007-08. It didn’t even include the possibility of such a crash occurring. And it certainly hasn’t been a reliable guide to getting out of the crisis, the worst since the Great Depression of the 1930s.

So what are the problems according to Blanchard and Summers? In their view, “the events of the last ten years have put into question the presumption that economies are self stabilizing, have raised again the issue of whether temporary shocks can have permanent effects, and have shown the importance of non linearities.”

Only mainstream macroeconomists could possibly have thought that capitalism is self stabilizing. The rest of us—who have read Marx and Keynes as well as the work of Robert Clower, Hyman Minsky, and Axel Leijonhufvud—actually knew something about the roots of capitalist instability: the various ways a monetary commodity-producing economy might (but not necessarily) generate imbalances and instabilities based on the normal workings of the system.

Yes, of course, temporary shocks can have permanent effects. How could they not, when tens of millions of people are thrown out of work and, especially in the wake of the most recent crash, inequality has soared to new heights?

And then there are those “non linearities,” the idea that financial crises are characterized by feedback effects such that shocks, even small ones, “are strongly amplified rather than damped as they propagate.” Bank runs are the quintessential example—whether customers demanding their deposits in the first Great Depression or the run on financial institutions (including insurance companies that issued credit default swaps) that occurred in the midst of the second Great Depression. But that’s not all: when corporations, facing a declining profit rate, choose to sell but not purchase, they make individually rational decisions that can have large-scale social ramifications—for workers, indebted households, and other corporations (on both Main Street and Wall Street).

So mainstream macroeconomists appear to be waking up from their slumber and seeing capitalism as it is—and as it has functioned for 150 years or so.

You’d think, then, with all the rhetoric of reform and revolution, they’d be in favor of questioning the entire edifice of their theories and models. What we get instead is a bit of tinkering, along the lines of the following: (a) monetary policy is limited because of low interest-rates (although it’s still expected to provide generous liquidity in the even of another shock); (b) more active financial regulation, which still may not be able to keep up with the quickly changing and complex structure of the financial sector and actually prevent financial risks; thus (c) fiscal policy should once again be important, both because of the limits on monetary policy and financial regulation and because, with low interest-rates, government debt is less significant.

No, you’re not mistaken, it sounds a lot like a mainstream version of Keynesian macroeconomic policy, which is consistent with the subtitle of the Blanchard and Summers paper: “Back to the Future.”

That’s it? That’s all we’ve learned in the last ten years? Not a word in their paper about the international dimensions of macroeconomics—nothing about international contagion (e.g., the fact that the crisis started in the United States and then engulfed the rest of the world) or cross-border capital flows. And, perhaps even more important, there’s no discussion of inequality and the role it played both in creating the conditions for the crisis or the way it has characterized the nature of the recovery.*

There’s no reform being proposed here, let alone a revolution. It’s just business as usual, which is exactly the way the recovery itself has been treated.

In the end, Blanchard, Summers, and the other participants in the conference are the macroeconomists who developed the current models and policies. Thus, for all they might venture some mild criticisms of the pre-crisis orthodoxy and call for some new ideas, they are so invested in the status quo, no one should expect a truly radical rethinking from them.

To expect otherwise is just laughable.

 

*Yes, there was one paper in the conference on inequality, by Jason Furman, but it was about growth, not macroeconomic policy. The theme of inequality was not taken up in the rest of the conference—and it was even ridiculed (e.g., in terms of the research currently being conducted in the IMF) by Summers in the final session.

 

From highway to master

Adam Smith’s Wealth of Nations makes for uncomfortable reading these days. That’s because, as my students this semester have learned, the father of modern mainstream economics—who has become so closely (and mistakenly) identified with the invisible hand—held a narrow theory of money and advocated extensive regulation of the banking sector.

This is contrast to the obscene growth of banking in recent decades, which Rana Foroohar observes “isn’t serving us, we’re serving it.”

According to Smith, the “judicious operations of banking” did nothing more than convert dead stock into active and productive stock—”into stock which produces something to the country.”

The gold and silver money which circulates in any country may very properly be compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either. The judicious operations of banking, by providing, if I may be allowed so violent a metaphor, a sort of waggon-way through the air, enable the country to convert, as it were, a great part of its highways into good pastures and corn-fields, and thereby to increase very considerably the annual produce of its land and labour.

Moreover, Smith also argued, banks were susceptible to speculative crises. Thus, even in his system of “natural liberty,” the banking sector needed to be regulated, in order to lessen the likelihood of such crises and to minimize the suffering of the poor when they did happen.

To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them, or to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support. Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.

Those warnings and regulations, of course, disappeared from contemporary mainstream economics—even as the financial sector continued to increase in size and significance within the U.S. economy.

Today, financial profits (the blue line in the chart above) represent more than a quarter of total corporate profits in the United States, although the financial sector provides only 4.3 percent of American jobs (the red line in the chart).

Moreover, as the profits of the financial sector (the purple line in the chart above) have grown—reaching still another record high of more than $500 billion in 2016—the distribution of wealth has become more and more unequal—such that, in 2016, the share of total wealth owned by the top 1 percent (the green line in the chart) was more than 37 percent.

And it’s not just the financial sector. As Forohoor explains, corporations outside the banking sector are copying the spectacularly successful model:

Nonfinancial firms as a whole now get five times the revenue from purely financial activities as they did in the 1980s. Stock buybacks artificially drive up the price of corporate shares, enriching the C-suite. Airlines can make more hedging oil prices than selling coach seats. Drug companies spend as much time tax optimizing as they do worrying about which new compound to research. The largest Silicon Valley firms now use a good chunk of their spare cash to underwrite bond offerings the same way Goldman Sachs might.

The fact is, financial wheeling and dealing has—after a brief interlude—returned as the tail that wags the economic dog in the United States. It manages to capture an outsized share of profits, even as it creates increased instability and obscene levels of inequality.

It should be clear to all that finance has been fundamentally transformed since Smith’s day, from a highway that was supposed to serve us into a master that we serve.

10 years after

The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought — Rudi Dornbusch

Last week, a wide variety of U.S. media (including the Wall Street Journal and USA Today) marked what they considered to be the ten-year anniversary of the beginning of the global economic crisis—from which we still haven’t recovered.

The event in question, which occurred on 9 August 2007, was the announcement by international banking group BNP Paribas that, because their fund managers could not calculate a reliable net asset value of three mutual funds, they were suspending redemptions.

But, as I explain to my students, “Beware the appearance of precision!” For example, the more numbers after the decimal point (2.9, 2.93, 2.926, etc.), the more real and precise the number appears to be. But such a number is only ever an estimate, a best guess, about what is going on (whether it be the growth of output or the increase in new home sales).

The same holds for dates. It would be odd to choose a particular day ten years ago that, among all the possible causes and precipitating events, put the U.S. and world economies on the road to the Second Great Depression. That would be like saying World War I was caused on 28 June 1914, when Yugoslav nationalist Gavrilo Princip assassinated Archduke Franz Ferdinand of Austria. Or that the first Great Depression began on Black Thursday, 24 October 1929.

Given the centrality of housing sales, mortgages, and mortgage-backed securities in creating the fragility of the financial sector, we could just as easily choose July 2005 (when, as in the green line in the chart above, new one-family house sales peaked), January 2006 (when, as in the blue line, new privately owned housing units starts peaked), or February 2007 (when the Case-Shiller home price index, the red line, started its slide).

Or, alternatively, we could choose the third quarter of 2006, when the U.S. corporate profit share (before taxes and without adjustments) reached its peak, at almost 12 percent of national income. After that, it began to fall, and the decisions of capitalists dragged the entire economy to the brink of disaster.

Or the year 2005, when the profits of the financial and insurance sector were at their highest level—at $158.3 trillion—and then began to decline. Then, of course, it was bailed out after falling into negative territory in 2008.

Or, given the centrality of inequality in creating the conditions for the crash, we can go all the way back to 1980, when the share of income going to the top 1 percent was “only” 10.7 percent—since after that it started to rise, reaching an astounding 20.6 percent in 2006.

Those are all possible dates, some of course more precise than others.

What is important is each one of those indicators gives us a sense of how the normal workings of capitalism—in housing, finance and insurance, corporate profits, and the distribution of income—created, together and over time, the conditions for the most severe set of crises since the first Great Depression. And now, as a result of the crash and the nature of the recovery, all of them have been restored.

Thus creating the conditions for the next crash to occur, ten years after the last one.