America Heads Toward Another Financial Crisis as Congress Does Nothing
However, averting a replay of the credit boom and bust cycle, along with addressing stagnant wages, increased inequality, and a myriad of other issues will require our democratic representatives to add fostering full employment and price stability to their job descriptions.
It’s instructive to recall the period before the financial crisis, bearing in mind the economic conditions and the speculative lending that led to the housing boom and bust. Why didn’t central banks do better to manage economic activity? In part, the answer is found in ideology and predisposition -- central banks are owned and operate primarily in the interests of member banks.
Similarly, the consensus fostered by the finance sector was that efficient markets and individuals acting in their own self-interest resulted in the most optimal outcome for all.
More importantly, the indicators that had an impact on decisions to raise rates -- unemployment, inflation, wage growth, and others -- were and remain very weak, with GDP numbers consistently revised down. In the analysis of central banks, reliance on private credit was the primary fuel for economic activity, leaving little room for potentially devastating rate increases.
What do our elected representatives need to know to manage the economy? Primarily the same thing central bankers know: as monopoly issuers of money, they don't have spending constraints. Just like central banks create money for asset purchases, sovereign currency governments are monopoly issuers of money capable (with their budgetary priorities and decisions) of supporting stable, sustainable economic activity.
As economist Warren Mosler states in his Mosler’s Law: “There is no financial crisis so deep that a sufficiently large tax cut or increase in public spending cannot deal with it.”
We live in a world of fiat money that isn't backed by a commodity or physical aspect to give it value. Instead, money derives value from its ability to service debts -- public and private -- primarily bank loans and taxes that regulate the quantity of money in circulation at the time. The value of money is measured by inflation, wherein too much money is chasing too few goods and prices go up or vice versa.Yet, recent events provide another reminder that we still live in a world where "linguistic gymnastics" are required to keep markets from getting schizophrenic.
First, the U.S. Federal Reserve removed the word “patient” from its “forward guidance” and market volatility ensued. This subsequently required none other than Fed Chair Janet Yellen to clarify that removing “patient” doesn't mean that the Fed would become “impatient.”
This is all too much of a reminder of the "Committee to Save the World" days when the media waited with baited breathe and parsed ad nausea the real meaning of "irrational exuberance" or whether rates might go up a quarter of a percent...or not. Oh the made-for-TV drama that culminates in solidifying banking's primary position in the economic equation.
In the U.S., as if on cue, the House produced a budget continuing wrongheaded efforts to put the squeeze on government spending and investment. Now, even defense is on the chopping block, but at least two-thirds of the proposed cuts are from programs that help lower-income Americans.
The budget passed would cut $5.5 trillion in spending, repealing Obamacare and cutting Medicaid, food stamps, education, and many other programs. These proposals are all in the name of fiscal responsibility and are efforts to “balance the budget.” Ultimately, however, they fail the American people.
In the UK, party manifestos and electioneering provided a choice between reducing public debt and continuing reliance on credit-fueled housing inflation. Labour's promise to “cut the deficit every year” with fiscal rules -- leading to surplus -- begs belief in light of what we know about modern money and the effects of taking money out of the economy, with inflation and growth consistently below expectations.
The Tories are fairly transparent in their willingness to leave running the economy to banking interests, proposing extensions in some policies to extend the housing price boom without supporting increased supply.
The U.S. Federal Reserve responded to the crisis with the authority and lessons learned from the Great Depression, creating money and buying up bad assets and offering near-zero interest rates in an attempt to increase the circulation of money in the economy.
Asset prices and employment have seen mixed results, however, in part because the central banks' partner, democratically-elected institutions, failed in their budgetary, spending role. The public interest suffers with threats of government shutdowns over debt ceilings, spending sequesters, and false understandings about the nature of public money.
In 1969, famed economist Paul Samuelson wrote, “Still to be argued out within the guild is the proper quantitative potency of monetary versus fiscal policy.”It is a great irony that our elastic money system proved to be an asset in response to the crisis, saving many banks and corporations with direct loans and guarantees while our democratic representatives failed to understand their ability to positively mitigate the negative effects.
While pensions and unemployment insurance provided a major stabilizing influence to support spending by families and the elderly, even these programs are now continually under attack. With debt and credit driving economic activity, we are only sowing the seeds for yet another crisis.
Echoing the words of Abba Lerner in his work, Functional Finance, Samuelson concludes: “What is important about the budget is whether it is inflationary or deflationary, not whether balanced or unbalanced.”
This is what we must remember and our elected representatives need to know. While the parties may be wrong in their view, the public bears responsibility for our failure to demand what has been the foundation of western society and competitiveness and we must resolve to support change. Public investment in education, infrastructure, innovation, and technological progress have been the recipe for success in increasing standards of living.
Contact your elected representative and remind them of their responsibility to support sustainable economic growth with full employment and price stability. Without our efforts, we will remain mired in an economy wherein the expansion and contraction of private credit will support economic growth and we can't afford another banking bubble without equipping them with the knowledge of how to respond -- so that one day, as Abraham Lincoln said, "Money will cease to be master and become the servant of humanity.