Sanders and the Fed’s Delusions


Bernie Sanders rails against the recent Federal Reserve decision to increase interest rates as another sign of a “rigged economic system.” In a New York Times editorial (“To Rein In Wall Street, Fix the Fed,” Dec. 23, 2015), he charges the Fed with being corrupted by the banks it is supposed to regulate. Echoing Occupy Wall Street, he accuses the banks of failing to serve America and the government of failing to make the banks serve America. He believes that credit, if granted in the right amounts and invested in the right projects, could be a blessing to hard-hit Americans – rather than what it really is: money capital advanced in order to flow back even bigger to the banks. He complains of a shortage of credit and too much debt; or: it tastes terrible and the portions are too small.

Banking without money

Sanders’ guideline for Fed policy is cynical: “As a rule, the Fed should not raise interest rates until unemployment is lower than 4 percent.” So 4 percent unemployment is ok, but 5 percent is too much? 7.5 million Americans out of work is bad, but 6 million is ok? That’s what counts as radical in American politics.

Sanders does not say why the Fed raised interest rates or why the big banks would want to raise them, except that they are worried about “runaway inflation.” Its as if he isn’t reading what they write. The central bankers say they have been flooding the financial system with liquidity for the last 8 years as an emergency measure and they think the emergency is partly over. Of course, they are worried about inflation, but only theoretically; they don’t see any evidence of it. Quite the contrary: the Fed has been worried about deflation in the price level.

In its last meeting, the Fed committee in charge of open market operations decided to raise interest rates on overnight funds within the Fed system. This is the market in which the Fed intervenes when bothering to set interest rates at all. This is not the rate at which most people borrow money, which is not overnight but normally for one year or five years. So its not clear what effect this has on the longer term interest rate.

In any case, an increase from zero to 0.025 percent hardly compares to times when the Fed really raised interest rates to fight inflation, like Reagan did in 1982 to withdraw credit from the system in a big way and cause a collapse in the economy. Nevertheless, Sanders says that this quarter point increase is “a disaster for small business owners who need loans to hire more workers and Americans who need more jobs and higher wages.”

Sanders takes the dogma seriously that low interest rates are a means for capital growth. But it is not just interest rates that determine whether businesses who want loans get them. Its their creditworthiness, or their promise of future payments. This is already “gambling” by both parties: by the lender that the money will come back bigger and by the user that the use of this money will make it grow bigger.

Sanders wants a profitable banking system and he wants the banks to make more loans to the productive sector of the economy. The funny thing is: how do banks make profits? By loaning. Their criterion is the same as any private business: can the borrower pay back more than the money loaned out? They are not shy about judging what makes money for them. They look at the American economy and they have loaned money where they want to; if they see a borrowing partner, they make a contract. That’s their job and they are doing it.

Sanders thinks the banks are making bad judgments about who gets the money. But the banks would be loaning to every corner pizza shop if it promised to make money; they just judge that this isn’t profitable. Why should they loan money when they don’t see creditworthy customers to loan to? Sanders wants the banks to be profitable, but he doesn’t want them to make profitability their criteria.

The fact that interest rates are low while the Fed is pumping the banking system with liquidity means that the banks are flooded with liquidity that they don’t need or ask for. Sanders writes:

“Since 2008, the Fed has been paying financial institutions interest on excess reserves parked at the central bank — reserves that have grown to an unprecedented $2.4 trillion. That is insane. Instead of paying banks interest on these reserves, the Fed should charge them a fee that would be used to provide direct loans to small businesses.”

For some reason, Sanders is worried that with 2.4 trillion in excess reserves, the banking system is in danger of not having money to lend out. He thinks that if the government charges the banks a fee, becoming a type of small business bank, there would be no excess reserves and the banks would find creditworthy customers.

This is currently being done in Europe and Japan with negative interest rates. They want idle money to be working and boosting their economies. What’s going on when people are willing to pay for the privilege of parking their money in the bank? They are saying that paying a quarter of a percent to a bank to hold their money is better than lending it and losing it.

Here’s the rub: before money can serve as a means of payment or as capital – money that makes more money – it has to be a store of value. Right now, the world is falling back on this primitive function of money. The central banks are anxiously hoping that their money can keep its value because no one trusts investment.

This is driving the policy makers crazy. They have the absurd idea that if the central banks pump money into the banks, this can force something to happen in the economy that the economy can’t do itself. This is pushing on a string; nothing happens. A central bank can deny credit, as Reagan did in the early 80s, to get rid of price inflation, but by supplying liquidity it can’t force credit relations to take place. Credit means credo, “to believe,” and nobody can make the bankers believe that money will grow just because there is more of it.

So Sanders isn’t the only one holding this idea. All monetary policy labors under this contradiction.

In banks we trust

If Sanders wants the bankers to make loans in the public interest, the logical consequence would be to nationalize the banking system. This is what Mitterrand did when he took power in France in 1981: he said that French banking system was not supporting the French economy. French banks were looking around the world and finding things to do outside France, so they were making in a rational way, but not serving the French economy directly. So he nationalized a good part of the French banking system.

Sanders is timid in comparison with his European social democratic counterparts. He doesn’t like the fact that the Fed is a government institution with a private-corporate structure. He wants the Fed’s board of directors to include “labor, consumers, homeowners, urban residents, farmers and small businesses.” He wants to integrate the Fed into ordinary politics. This would still be a huge change in the banking system – a de facto nationalization from above. So how would these guys set overall policy for the Fed in its relations with the private banking system?

The first task of a central bank is to create the money that a capitalist society needs. Critics of the Fed rarely ask the simple question: why is the state power making the money of a free market economy? Money is “legal tender” by force of law; this is what gives monetary tokens the ability to function as means of payment and circulation. Everyone who sells is forced to accept this stuff as payment for transactions. Without the force of law, money would just be paper. In states with failed economies, their money ceases to be money; it can’t fulfill its function as a means of payment and people resort to using everything else.

In a developed capitalist society with a private banking system, the money the state creates is sucked into the banking system because the banks are the payment institutions for the whole society. Money takes on a different function as the reserves of the private banking system. This is substitute money; its not the same as real money because it doesn’t have the force of law behind it. What makes it money is that the state makes the exchange between reserves and bank account money seamless. It is not that the Fed’s real purpose has been “hijacked” by the banks, as Sanders thinks. The state wants it this way because it wants its money to function as capital.

The whole idea of a capitalist credit system is that profit-making should work out. Somebody has to decide who gets credit. The state trusts this to the bankers because all payments pass through their hands and they act as the executive committee over all the economic activities in the society. By having Federal Reserve banks owned and directed by private banks, the state is in touch with the money needs of the private banking system. The Fed monitors bank reserves and wants to know: are the banks loaned out? Are there creditworthy customers who they can’t loan to? Who better to judge this than those who are in charge of making money grow?

The futility of monetary policy

The banking system itself decides how much money there should be and the state asks how much of its money it should be producing. Monetary policy has two targets: the quantity of bank reserves and short term interest rates. These are really two sides of the same coin. Its just buying and selling securities, done in a capitalist manner so that it doesn’t disrupt the capital markets. This leads to crazy debates with amazingly complex mathematical models about whether to target the quantity of money or interest rates. This changes over the years and the debate never ends. Central bankers have the idea that if they just pick the right amount of money, there will be 3 percent economic growth forever.

Their theory is wrong because they see everything in terms of quantity rather than asking: what is money? Anyone buying a Persian rug looks at the wool, the silk, the colors, all the real qualities. Not with money. The quality everybody notices about this commodity is that its a pure abstract quantity: how much? This misses what it is a quantity of: the generalized power of property to get hold of everything and to increase this power. This is the only power that capitalists are interested in. They could care less about material things except for the value they can extract from them; this applies to people as well.

Now and then money loses this power to augment itself. Central bankers have no idea why this happens. They notice that there’s too much stuff already out there in the economy, so they have some clue, but they don’t see that its a loss in the substance of money itself. They always think there was too much money, so if they make less of it, this will restore economic growth. But if bankers lose faith in their credit and everyone is looking for safety, monetary policy can’t do a damn thing. That’s why the financial press is now worrying that the central banks will have less tools to work with when the next crisis hits. If there is 2.4 trillion in excess reserves in the banking system, they can’t pump in another 2 trillion. And they can’t pretend that interest rates were too high or reserves were too low.

Sanders just takes all this for granted with his wrong theory of money and banking. As a social democrat, he thinks that the capitalist economy has to benefit the working class. He sees economics as about making things for people to use and live; he doesn’t see capitalism as having a different purpose, even though he knows every capitalist asks the question: how can I make more money? He doesn’t wonder how money grows bigger. He just thinks that it should grow bigger and that everyone benefits from this because an economy is about benefiting people. He criticizes capitalism for what it should be able to do for working people but doesn’t. He doesn’t recognize that capitalism never works out for the working class because it doesn’t have that purpose. This is the huge divide that separates social democracy and socialism. These aren’t two ideas along a spectrum, in which one idea shades into another, but two opposing ideas.

Geoffrey McDonald is an editor at Ruthless Criticism. He can be reached at: