Cockeyed Economics

… I know it may sound funny
But people everywhere
Runnin’ out of money

Randy Newman, “Mr. President”

The passage of time is the Obama administration’s economic trump card. No matter that there are no encouraging signs at all of a turnaround toward an economy that brings well-paying jobs to workers who don’t have to rely on credit and holding multiple jobs in order to make ends meet – no matter anything, the administration will claim that it takes time for stimulus measures to take effect. Patience is the political virtue of the day. Just wait.

Put aside for the moment that this defense of the going economic game plan appears unfalsifiable: however bad things look, that just means we haven’t waited long enough. Consider the possibility that Obama’s recovery plan is fatally misconceived from the start. In that case, if present economic strategy continues, in the end the “new normal” will be a permanently indebted low-wage American worker.

There is good reason to believe this to be the case. Let’s look first at Obama’s fundamental justification for bailing out the bad guys and not the working majority, and then at the economic situation of the median worker, who will bear the burden of the consequences of a thoroughly cockeyed economic policy. Along the way, we will identify a few widespread misconceptions about the workings of the banking system. We’ll conclude with a look at the “new normal” promised by the prevailing elite consensus.

Obama’s Rationale for the Recovery Program

The president is not deaf to the resentment felt by so many Americans that his rescue bails out the perps while leaving the rest twisting in the wind. In an April speech at Georgetown University, he addresses this very issue:

“And although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks- ‘Where’s our bailout?,’ they ask -the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.” (The New York Times, April 14, 2009 “Obama Stands Firm on a Sweeping Agenda”, by Peter Baker)

Obama’s reference to the “multiplier effect” is straight out of Economics 101: a dollar injected into the income stream generates more than a dollar’s worth of spending power, because when that dollar is spent it becomes someone else’s income. It is then spent again, becoming a new recipient’s income and is spent yet again. and then again, and … Here’s an example of Obama’s Georgetown scenario, in which banks extend “loans to families and businesses” : a bank lends $5 million to build a factory. Out of this sum, the factory owner pays suppliers for, say, steel and concrete, and pays wages to builders. The suppliers and builders will spend (consume) their new incomes, which thereby creates new purchasing power for the recipients. And on it goes. The same kind of income chain is created when banks lend to “families”: household spending becomes income to owners and employees of retail outlets, whose investment (by owners) and consumption (by employees) constitute further expenditures, which in turn… You get the picture.

All this additional spending triggered by the initial injection, Obama claims, “can ultimately lead to a faster pace of economic growth.” The ultimate result will be an increase in employment-generating investment, growth in wages and spending, increased output and higher profits – in short a resumption of the economic growth that is supposed to have graced the economy from the end of World War II until just a few years ago.

Obama’s reasoning is rife with factual inaccuracies, false presuppositions, misconceptions and strategic omissions. Among these is a seriously flawed conception of how the banking system works.

Misconceptions About What Banks Do

School kids are taught that banks lend from their reserves, which consist in John’s deposit, which is then lent to Mary. The interest paid to depositor John is less than the interest charged to borrower Mary, and the difference is what constitutes the bank’s profit. This is said to be how banks make money. Later on this story is filled out by adding that it is consumer deposits and government infusions of money which together make up banks’ total reserves. By the time the kids get to college, there is scarce talk of consumer deposits. Now the financial equivalent of Let There Be Light is the decision by the central bank to create money. The Obama administration plans and executes its economic policy within this fictitious framework.

The story hooks you by starting with the truism that banks lend at interest rates greater than the rates paid to depositors. Fine. But what makes the textbook story social-science fiction is the imagined relation between credit money and debt money: first, government creates credit money, which is then distributed as reserves to local banks, which proceed to issue it as debt money to borrowers. Thus is created a significant source of household spending power. The economic catechisms stipulate the central bank as the monetary equivalent of the scholastics’ Unmoved Mover, creating money from nothing and thereby making possible the world of various and sundry banking activities with which we are all more or less familiar.

Except that isn’t what happens. The causal primacy of the central bank was never established by empirical research. It is an axiom of “static equilibrium” theoretical models of how the economy works. The first economists to get down to testing the truth of the central-bank-as-Prime-Mover claim were late-1970s post-Keynesians, of whom the US economist Basil Moore is credited with establishing that it is simply not the case that increased lending by banks is enabled by their prior accumulation of excess reserves bolstered by consumer deposits and/or government infusions of liquidity. Money is indeed created from nothing, but it is in fact the lowly banks themselves that initiate the process. The implications are enormously important for our grasp not only of the terminal flaws in current theory and policy, but also of the only alternatives available with the slightest chance of heading off an emerging epoch of long-term austerity for working people.

So how exactly do banks work, and why is the answer important?

What Banks Actually Do

The truth about bank dynamics is not the private property of heterodox economists. More than 10 years after the post-Keynesian revelation, Finn Kydland and Edward Prescott, two Nobel Prize winners at the Federal Reserve Bank of Minneapolis, published “Business Cycles: Real Facts and a Monetary Myth” in the Bank’s Spring 1990 Quarterly Review. They found that credit money was created by ordinary banks well before the creation of central bank money. And before professional scholars had published technical-theoretical work establishing the falsehood of the party line, experts in the field were stating the same.

The facts of the matter have been clearly stated from the horse’s mouth. This is from a booklet titled “Modern Money Mechanics”, released in 1961 by the Public information Center of the Federal Reserve Bank of Chicago:

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to borrowers’ transaction [checking: AN] accounts.”

And here is Graham Towers, Governor of the Bank of Canada, 1935-1955:

“Banks create money. That is what they are for. .. [Making] money consists of making an entry in a book [computer: AN]. That is all…Each and every time a bank makes a loan, new bank money is created – brand new money.”

When a bank extends a loan, it merely credits the borrower’s checking account in the amount of the loan. The money was previously paid in to the bank neither by household depositors, nor by the central bank.

Why Does It Matter?

What is striking is that the Prime Movers are the household and the (usually small) business owner. (My focus here is on the consumer, whose spending accounts for 66-73% of GDP.) It is in response to events set in motion by the initial loan that banks petition the central bank for reserves, to cover losses, defaults and the like. If the consumer is willing and able to spend, (s)he seeks a loan from the bank, and the stream of spending has begun. The lower the level of consumption demand, the less the need for infusions from the central bank. We therefore expect that should central banks flood the banks with liquidity in the face of low consumer demand, these reserves will either be used, say, to further consolidate the industry by buying weaker banks, to pay bank managers obscene bonuses, to goose the stock market to produce a speculative asset rally or to function as a cover for underlying insolvency. So it’s not that these liquidity infusions are of no use. It’s just that they contribute nothing to their stated aim, which is, in Obama’s words, “to lead to a faster pace of economic growth.”

Obama chooses his words with great care. He tells us that “a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses.” “can” Sure it can, but only if consumers / households are perceived by banks as credit worthy and households are in fact inclined to borrow. But the dire circumstances of households originated well before September 2008. 1973 was the peak postwar year for the median wage, which has been in secular decline for 36 years, even as the costs of health care, child care and education have risen at a quicker pace than inflation. Households have continually tried to adapt to this crunch, by sending more household members into the labor force, by taking on multiple jobs, and finally by leaning more heavily on the credit crutch. This overall circumstance has been dramatically magnified by the current crisis, during which $2 trillion of retirement savings has been lost. Recent survey indicates that 70% of workers intend to work during their retirement years. None of this has been taken account of in the recovery plan. As in the textbooks, the consumer is assumed to be ready and able to spend and to incur debt.

In this context Obama’s invocation of the multiplier is preposterous: “a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses.” In order for the $1 trillion that the Fed has lavished on banks to produce “ a faster pace of economic growth” , unprecedentedly indebted households and businesses would have to take on an additional $8-10 trillion in debt. Indebtedness would become a way of life. That seems to be the plan. More on this below.

An economic profile of the median wage earner paints a more vivid picture of the Obama policy’s impact on real people.

The Personal Finances of the Median Wage Earner

Let’s look at the US Census Bureau’s Consumer Income Report issued in August 2008, immediately before the eruption of the crisis. Calculations from these data will err on the side of optimism. The figures were compiled before a marked decline in the income and employment picture, and the figures for households are less alarming, for obvious reasons, than are the data for individuals.

According to the Report, real median household income is $50,233. Half of the households make more, and half make less. But let’s look also at a fatter figure, for households headed by married couples. These have a median income of $72,785.

We’ll focus on the household’s biggest economic decision, the choice to purchase a home. The median price of a single family home in the first quarter of 2009 was $169,000. It would cost the $50,233 household almost 3.5 times their annual income to buy the median-priced house. The median-priced home would appear to be more affordable for the headed-by-a-married-couple family taking in $72,785 a year. The price/income ratio for this family is 2.35. But not so fast. What do the family’s actual monthly expenditures look like?

Our assumptions will remain optimistic. Assume the couple puts down 20% on the new house, and takes a loan of $135,200. The current 30-year fixed mortgage stands at 5.75%, which will cost them $788.99 a month for the loan. Our couple is taking in $6,000.00 a month before taxes, so let’s do the tax numbers.

With their employers covering half of their Social Security and Medicare taxes, they are down 7.65% of the $72,000, or $5,508. Uncle Sam’s cut of 20% chops off another $14,400. Average state and local taxes come to about 3%, so we deduct another $2,160.

Our median couple is now taking in $4,161 a month. Assume they have health insurance, which we’ll figure at about $500.00 a month. Car payments and insurance will cost them somewhere between $500.00-$1,000.00, and gas at least $100.00-$200.00. Groceries for a family of 3 or 4 will cost an additional $600.00 a month. The median family uses cell phones, cable and the web, which we’ll generously price at $150.00 a month.

With monthly bills in the vicinity of $2,000, they’ve still not paid their housing costs. These include more than the mortgage payment of $788.99. They’re shelling out around $1,700 at a low property tax rate of 1%, roughly $1,000.00 for insurance and about $300.00 a month for utilities.

This leaves the Medians with a disposable income of $872.00 a month. But not really. There are additional costs which are not as easily calculable as the more or less essential ones identified above. Clothes are indispensable. Movies and dining out. Vacations have been considered by the so-called middle class as a fixed cost of good living, but an increasing number are having to scale down or flat out reclassify travel as a discretionary expense. Regular maintenance of the house and car, as well as addressing unexpected emergencies, including of course medical crises, are at least partially foregone by a rising number of regular folks. (Our ardently Republican family physician tells me that she is alarmed by the number of patients who tell her that they must cut back on food in order to pay for prescriptions.) Deductibles, out-of-pocket expenses and prescription drug payments are often sizeable. And there are the perpetually escalating costs of education and child care. That $872.00 a month is being whittled down to a pittance. And keep in mind that half of the median wage earners are worse off than this; half of that lower half lives below the official poverty line. No wonder the only way many people are holding their finances together is with the glue of credit.

This unenviable position is not static. There is the ongoing economic crisis, which we are assured by Obama-Bernanke will improve soon, even though cumulative job loss, declining wages, and increasing foreclosures and bankruptcies will persist for years. Many of what used to be the highest-paying wage earning jobs with the most generous benefits will disappear, and those remaining will suffer wage reductions of up to 50%, sharp reductions in health benefits and further erosion of the power of virtually impotent labor unions. The “restructuring” of the auto industry is the handwriting on the wall for the wage-earning population (the majority, remember, of the entire population). It is fantastic in the extreme to imagine, as the Obama team does, that greater working-class indebtedness is any part of a solution to embedded structural problems.

The Paradox at the Heart of the Problem

The upshot of this review of the theory and practice of Obama’s recovery plan is condensed in the lines from Randy Newman at the top of the article. The living standards of working people have been under assault by Democratic and Republican gravediggers of the NewDeal and the Great Society for 36 years. Global neoliberalism’s response to vanishing industrial investment opportunuties in the form of global excess manufacturing capacity, and to intensified global competition resulting from the successful reindustrialization of Europe and the emergence of formidable competitors in China, India, Brazil and elsewhere, has been to embark upon a worldwide cost-cutting campaign. And of course the costs targeted are labor costs. A successful campaign against wages and benefits depresses the largest source of the demand for GDP, the consumption of the masses. By the canons of any school of economic thought, this is a surefire recipe for depression. What is required to restore the economy to health -even capitalist standards of health- requires what is anathema to capitalism, namely a determined poitical-economic campaign to raise workers’ income and benefits dramatically.

Obama and his henchmen are insisting that this will be the happy result of the recovery plan. We have seen that this is nonsense. The prevailing sentiment of the financial elite unwittingly underscores the circular logic undermining the recovery plan. Here is the New York Times’s account of the thinking of the typical financial poobah:

”It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.” (Oct. 20, 2008 “One Day Doesn’t Make a Trend,” by Andrew Ross Sorkin.)

The banks won’t lend freely until the economic crisis is ended, but the crisis will continue as long as the banks refuse to lend to people who are broke. This is much like the paradox Keynes identified at the heart of every prolonged depression. With wages very low and unemployment very high, and assuming a closed economy (no export demand great enough to lift the entire economy), the only way for the private economy to recover is that investment demand resuscitate on a grand scale. We’re not talking about a few investors, but a wave of optimistic profit expectations mobilizing the entire class of investors. Recovery is large-scale investment. But capitalist investment is the result of individual decisions to initiate production and employment. And no rationall capitalist will invest in the midst of a depression. He will wait for the recovery before he risks an investment. But since recovery requires investment by the capitalist class as a whole, each capitalist will refuse to invest until all or most of the others do. The result is that each waits forever for the recovery, which of course never takes place.

Keynes saw that the logic of a private economy in depression would make it impossible for the depression to be overcome. He concluded that an economic agent outside of the private, individual-profit-seeking market system was required to provide a collective capitalist incentive to invest. This was to be the state. It turned out that war initiated and directed by the state managers was the only motivator sufficient to initiate collective investment by individual capitalists.

Mass Mobiization Replaces the Keynesian State: Shortening Labor’s “Unusually Long Fuse”

The above-described contradiction in the financial system today and the conundrum identified by Keynes during the Great Depression bear a striking resemblance, and exhibit two momentous differences. War in these times would be economically devastating, and the state is no longer capable of rescuing the private economy from its own suicidal tendencies. The state is now transparently -dare I say it- the executive committee of the ruling class, and is no longer governing in the interests of the industrial elite. It is the financial elite that conceives and often executes policy, and these fellows don’t depend on production and employment to make their fortune. They sell not widgets but debt, the most fitting product for a population consigned to perpetual austerity.

And enduring austerity is the only alternative given the imperatives and interests of the financial plutocracy. The media have been foreshadowing the structural changes that the economy is moving toward. In “Job Losses Hint at Vast Remaking of Economy” (NYT, March 7, 2009, by Peter S. Goodman and Jack Healy) we are told that “…growing joblessness may reflect a wrenching restructuring of the economy…. In key industries – manufacturing, financial services and retail – layoffs have accelerated so quickly in recent months as to suggest that many companies are abandoning whole areas of business. “These jobs aren’t coming back,” [said a chief economist at Wachovia]”A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than in the United States. There are going to be fewer stores, fewer factories… Firms are making strategic decisions that they don’t want to be in their businesses.” The article quotes a Stanford Hoover Institution economist as saying “The decimation of employment in legacy American brands such as General Motors is a trend that’s likely to continue. We have to stimulate the economy to create jobs in other areas.”

And what might these new jobs be in an America now resigned to ongoing deindustrialization? The Bureau of Labor Statistics released a study in 2006 identifying the occupations projected to add the greatest number of jobs between 2006 and 2016. These are not jobs characteristic of a high-wage, high-productivity economy. They are: nursing aids, orderlies and home health aids; registered nurses; retail salespersons; customer service representatives; food preparation and serving workers; general office clerks; personal and home care aides; postsecondary teachers; janitors and accounting clerks. No widget producers here.

In the Georgetown speech Obama alerts us that “We must lay a new foundation for growth and prosperity, where we consume less at home and send more exports abroad.” Obama has repeatedly underscored that the main propellants of “new normal” growth will be investment and exports. He is in tune with the neoliberal Economist magazine, which, in expanding on the notion that consumption will play a much diminished role in future US growth, writes “Something else will have to grow more quickly. Ideally that would be exports and investment.” (May 6, 2009)

The picture is clear: intensified global competition and globally overbuilt industrial capacity makes cost reduction, i.e. wage reduction, a strategic imperative if the US is to regain the competitive edge it enjoyed in the boom years 1949-1973. Policymakers are convinced that manufacturing activity is gradually shifting from the US, Europe and Japan to China, India, Brazil and other low-wage countries, so that US companies will be increasingly in competition with predominantly low-wage countries. US workers will have to make the necessary “adjustments.” Obama was quite explicit in an interview on September 18 with the editors of the Pittsburgh Post-Gazette. “Pittsburgh is now having to pay attention to what happens in Beijing and Bangladore and Eastern Europe in ways that in the past it didn’t have to pay attention to… The manufacturing base that employed so many people, the decline in that sector of the economy took decades. It didn’t start last year, it’s been going on for two decades. And reversing that and rebuilding it is going to take two decades as well.”

It doesn’t get any clearer than that. Remaking American industry in the image of the restructured General Motors and Chrysler will take decades, after which a leaner, meaner America employing workers making poor-country wages will rise from the ashes to become once again a great power whose economic prowess will once again match its military predominance.

This is the kind of “recovery” that current policy serves. There is no Keynesian government to counter this grand plan. Only mass politics can address this situation. We must not be embarrassed to employ the argot of old: the objective conditions for mass mobilization are as conspicuous as they’ve ever been. A mass movement organized around, say, continuously widening inequalities not seen since the early 20th century could not fail to make a difference. Mainstream media report mass disaffection with permanent war and transparently elite-driven policy. And the Left remains dormant.

In “In America, Labor Has an Unusually Long Fuse” Steven Greenhouse of the New York Times (April 5, 2009) hits the nail on the head. He contrasts the relative miitancy of European labor, which has in fact made it far more difficult for European capital to impose neoliberal “reforms” on workers there, with the inertia of US workers:

“…[M}ore than a million workers in France demonstrated against layoffs and the government’s handling of the economic crisis…French workers took their bosses hostage four times in various labor disputes. When General Motors recently announced huge job cuts worldwide, 15,000 workers demonstrated at the company’s German headquarters. But in the United States, where G.M. plans its biggest layoffs, union members have seemed passive in comparison… Unlike their European counterparts, American workers have largely stayed off the streets, even as unemployment soars, and companies cut wages and benefits.”

Curiously, Greenhouse fails to mention the 250 workers at Republic Windows and Doors in Chicago who occupied their factory in response to announced announced layoffs and the closing of the factory. The result was a $7.5 million settlement, giving each Republic worker 8 weeks salary, all accrued vacation pay and 2 months health care. This was admittedly a limited victory, but why not think of it as a “green shoot” of a different kind?

ALAN NASSER is professor emeritus of political economy at The Evergreen State College in Olympia, washington. He can be reached at

Alan Nasser is professor emeritus of Political Economy and Philosophy at The Evergreen State College. His website is:  His latest book is Overripe Economy: American Capitalism and the Crisis of Democracy. He can be reached at: