Following the onset of the Great Recession there was general consensus amongst the economic mainstream in the U.S. that the monetary policies of the Federal Reserve were by degree useful and necessary. There was less consensus around the need for fiscal policies, direct action by the Federal government to boost demand for goods and services that might have put some of the unemployed back to work. The view expressed by the New Keynesian mainstream is that the monetary policies undertaken— programs to keep interest rates low and the financial asset purchases through Quantitative Easing (QE), were / are less than optimal but better than nothing. Left intentionally unexplored in the unified frame of Western economics are the class dimensions of fiscal versus monetary policies. Monetary policies are financial policies— they are intended to work on / through finance. Keeping interest rates low affects the cost of bank money whereas a government jobs program to put the unemployed to work directly benefits the unemployed. The implication of existing policy, that banks and finance are necessary to a functioning economy but that meaningful employment isn’t, is banker economics hidden behind a façade of public interest.
Along the way the Federal Reserve and Bank of England have been accused of a lot of things and a fundamental question is why there isn’t clarity about what their programs actually accomplish? A recent paper from the Bank of England (BOE), Britain’s Central Bank, clarifies the role of commercial banks in the creation of money and also provides an explanation of what QE does nearly identical to the one that I provided a couple of years back. This doesn’t mean that either the Bank of England or I provided the only, or even an accurate, explanation of QE. At last count I had identified three other full-blown explanations of QE that bore no relation to one another. But the BOE explanation does revive former Fed Chair Ben Bernanke’s expressed intent with QE— to drive interest rates down and financial asset prices higher through taking financial assets out of circulation and replacing them with the money to purchase other financial assets. There appear some technical questions about the extent to which this was actually accomplished— the persistence of ‘excess’ bank reserves suggests that much of the proceeds from asset purchases remained as commercial bank deposits. But the Bank of England is making their case with clear understanding of the arguments to the contrary.
Graph (1): Recovery in the wealth of the already wealthy through the recovery of financial asset prices stands in stark contrast to the ongoing decline in median income. The decline in incomes has real impact on the lives of far more people than does the rise in stock prices. Advocates of Federal Reserve monetary policies are today consigned to claiming that ‘the economy would have been worse’ without Fed actions. But another way of saying this is that thanks in large measure to these policies the economy could not be better for those at the very top. The stock index represented is the Wilshire 5000.
The intent of monetary policies is relevant regardless of actual outcomes because it speaks to the realm of concern behind Fed decisions. Did the Federal Reserve intend to inflate the prices of financial assets owned overwhelmingly by the very rich? The answer given by Mr. Bernanke (link above) and restated in the Bank of England paper is: yes, absolutely. As stated, the mechanical goals of QE were / are to replace existing interest bearing financial assets with cash in a manner that will be widely diffused through financial markets while lowering interest rates. Restoring bank lending through building ‘excess’ bank reserves, the oft-stated purpose, had nothing to do with it. In the first place, as has been argued ad infinitum in the economic press and reiterated in the BOE paper, banks create deposits through making loans— existing reserves are largely irrelevant to the capacity of banks to make loans. In the second place Wall Street had so reduced the number of creditworthy borrowers by killing the economy that they lacked the customers to reasonably make trillions of dollars of new loans. And finally, the broad circumstance leading up to and coming out of 2008 was of far too much private debt outstanding already— excess private debt was / is ‘the problem.’
Graph (2): Regular readers have seen this graph before but it bears repeating. Boosting financial asset prices as the Federal Reserve (and foreign Central Banks) has done overwhelmingly benefits the residual plutocracy that owns financial assets. The income of the top one-half of one-percent of income earners is very strongly tied to stock market returns. The assets that banks hold also tend to rise when interest rates are lowered. As can be seen by the almost straight blue line along the bottom of Graph (2), boosting the prices of financial assets provides absolutely no benefit to the vast majority of the population. And reviving the fortunes of the Wall Street banks that killed the economy without making substantial changes to them leaves them in place to destroy the global economy again.
The central challenge to the mainstream view that the Federal Reserve controls the quantity of money / credit is that it simply isn’t true (bank loans ‘create’ bank deposits). This plays out more broadly through financial ‘leverage,’ through the multiplication of credit. The Bear Stearns hedge fund that blew up at the outset of Wall Street’s unpleasantness of 2008 – 2009 was composed of bundles of home mortgages leveraged twenty to one that Bear Stearns leveraged again through the ‘repo’ market another ten times. Interest rates set by the Fed are the ‘price’ of financial leverage far more than they are the cost of business borrowing. The problem with the New Keynesian ‘savings’ view of bank lending is that it places a ‘natural’ limit on systemic leverage that does not exist. In their new paper (link above) the BOE attempts to get around this with implausible utterances about ‘prudence’ and ‘market forces’ that have conspicuously failed three times in the last three decades. And unbeknownst to most is that the Bear Stearns hedge fund, and any other highly leveraged hedge fund, was able to borrow at a tiny fraction of the rate that ordinary mortgage borrowers finance houses at. As borrowers put into high-cost sub-prime mortgages when they qualified for cheaper prime loans are most likely unaware, the price of leverage very much depends on where one exists in the social order.
To be clear, the concern here isn’t with ‘fixing’ the financial system. It is with the class dimension of monetary policy. The question is: are some, or even most, of us made worse off by making the very wealthy better off— the goal and the effect of Federal Reserve policies? The beneficiaries of rising financial asset prices have been bankers and corporate executives— the same bankers who have produced regularly recurring crises for three decades and the same corporate executives who have enriched themselves by diminishing the circumstances of labor. Low interest rates mean little to nothing to people who either can’t borrow or who wouldn’t be well served by borrowing bank money. Fed policies conspicuously haven’t benefited ‘the economy’ outside of financial returns for decades. The contention that ‘the economy’ would have been worse without Fed actions is from the perspective of those made better off by them— the economic circumstances of most citizens of the West, as can be seen in median income, are in continuing decline. But the era of financial speculation is back in full force. Mr. Bernanke was quoted the other day saying that he doesn’t expect interest rates to rise in his lifetime because the labor market isn’t ‘healing.’ This is certifiable nonsense. The reason why interest rates won’t / can’t rise is the same one I’ve been giving since 2009— interest rates are the price of financial leverage and ‘the economy’ is so highly leveraged that raising rates will near instantaneously crash the financial economy. The trigger in 2006 was the effect of the Fed raising the Fed Funds rate that affected variable rate mortgages made instantly unaffordable at higher rates.
None of this is to fundamentally disagree with the thoughtful economic mainstream that ongoing economic travail for most in the West is a function of excessive private debt. But this debt— both its issuance and its residual impact, is a function of existing political economy and not the other way around. The Federal Reserve could have bought houses with QE and the monetary impact would have been to replace some portion of the supply of available housing with bank deposits— money, the goal of QE as articulated in the BOE paper. And doing so possibly could have raised house prices. But the Fed bought the financial assets owned by the already wealthy instead. The pushback that houses require infrastructure to maintain gets to the heart of the issue. The Federal Reserve doesn’t have the infrastructure to maintain a large portfolio of geographically diverse houses so it gave hedge funds that also don’t have the infrastructure needed to maintain large portfolios of geographically diverse houses free money by inflating financial asset prices to buy the future slums of America.
This isn’t rocket science— use bank debt as a weapon to create a large, desperate indentured class through housing / auto loan / student debt boom-busts, crash the economy and buy real assets back for pennies on the dollar. People who used to ‘own’ their houses and work for a living now pay rent to the financial plutocracy while working McJobs to eternally repay ill-incurred debts. Should this read as hyperbole; household debt has barely fallen since 2006 while ordinary households have lost $6 trillion in household wealth. And living wage jobs lost in the Great Recession have been replaced overwhelmingly with minimum wage McJobs in the so-called ‘recovery.’ Meanwhile, the Obama administration has pulled out all of the stops with faux ‘mortgage relief’ programs to keep people paying ill-incurred debts to the banks under the same ‘sanctity of contracts’ nonsense that corporate America regularly ignores to discharge its debts. So the economic mainstream can talk / write about ‘the economy’ as a unified set of interests but Federal Reserve and Federal government policies tell a very different story.
Rob Urie is an artist and political economist. His book Zen Economics is forthcoming.