Financialization and the low burden of public debt

Financialization is a fuzzy concept. There are many definitions, and none is clear cut, at least to characterize the changes of the last 40 years or so, which is the period most authors associate with financialization. I'm not suggesting it's not a useful concept though.* In some sense, financialization refers to the last phase in the capitalist system (even if there are ways in which one might argue that capitalism was always financialized).

At any rate, going to the point I wanted to make, the financial burden of public debt went down in the 2000s, but that is not necessarily a good sign. I was trying to check the financial burden of public debt (i.e. the total spending on interests, out of total current spending) in the United States. The figure above shows that the financialization (ha, another possible definition) of the budget started with the Volcker shock, and ended more or less with the collapse of the dot-com bubble in the early 2000s.

The hike in interest rates in the late 1970s increased the financial burden of public debt, and with the lower output growth -- associated not just to higher interest rates and its effects on consumption, but also higher unemployment and lower wages which additionally impacted private demand -- debt dynamics was on the unstable side of the Domar rule (r > g) and public debt increased significantly in a peaceful period that was for the most part prosperous.

Public debt normally increased in periods of crises or of external threats (wars). In other words, public debt was an instrument for the preservation of society for the most part. There was also an agreement that public debt was a necessary instrument for the accumulation of capital, and it provided a secure asset for the functioning of the financial system. Btw, that was a point that was contentious, and not everybody accepted the Hamiltonian notion that public debt could be, to some degree, a blessing. Think of Andrew Jackson's payment of debt, and the various modern Cassandras afraid about the debt burden on future generations.

The rise of public debt since the 1980s (with the minor decrease in the late 90s) has served a very different purpose. While part of it can be seen as the reaffirmation of American Hegemony, with the increased military spending of the Reagan years (still low if compared to the heights of war, hot or cold), much of it was the result of lower taxes for the wealthy. The accumulation of debt was, like the hike in interest, necessary to discipline the labor class and control inflation.

In part, the result of that perverse use of public debt accumulation is that private agents have ramped up private debt in order to compensate for income stagnation. Think about college kids accumulating more debt to compensate the reduced public support for public universities. That of course goes hand in hand with the fact that most booms now are associated with some bubble (stock market, dot-com, housing, etc), or in the absence of a bubble we end up with a moderate lack luster recovery (the last decade), and what is confusedly described as 'secular stagnation.' The flip side is that the low burden of debt on this side of the 2000s, is not benign like the one from the 1950s to the 1970s, which was closer to what Keynes' notion of the euthanasia of the rentier.

It reflects the needs of the economy to maintain private debt under control in a relatively unstable economy. Something that is still necessary to the extent that labor is still very much being disciplined by macro and micro policies that keep wages under control.

* For a relatively recent discussion of the meaning of financialization and its relevance see Epstein (2015) here, and for an older discussion see Palley (2007) here.

Jane D'Arista: An Appreciation

By Tom Schlesinger

Throughout her career as an author, analyst, congressional staff economist and teacher, Ms. D’Arista has brought together several strands of heterodox economics. While she may be characterized accurately as one of the last great institutionalists, her work also defies easy classification. Perhaps the clearest way to view Jane is as a tough-minded empiricist who has produced critical, original insights into the functioning of the financial system and economy – and done so with the uncompromising goal of improving human welfare.

From the Introduction to the book Banking, Monetary Policy And The Political Economy Of Financial Regulation: Essays in the Tradition of Jane D'Arista. Read rest here. Jerry Epstein posted this on Elgar's blog too.

PS: Jane is also a poetess, see her book here. The drawing of her above was done by Robert D'Arista, her late husband.

Gerald Epstein on the Fed Signaling a Possible Policy Shift

Jerry Epstein was interviewed by the Real News Network. Among other things he said that:

"Typically in the past the Federal Reserve has been inviting a lot of investment bankers and financial market economists to the Jackson Hole Conference. This year's a little different. Janet Yellen and the Fed people didn't invite so many investment bankers. Instead, they invited a bunch of labor economists, which was a big change. Nevertheless, despite signals of an apparent shift in attention towards bringing unemployment down, Fed policy still remains toothless in helping out working Americans."

Full transcripts here.

Gerald Epstein on Deconstructing Fischer's Grim Economic Forecast

Gerald Epstein discusses how Fed Vice Chair Stanley Fischer's has ignored real solutions to improve the economy, like increasing wages.

Jerry Epstein on the financial crisis after six years

By Gerald Epstein

It has now been almost six years since Lehman Brother’s collapsed and, as Warren Buffett famously put it, all the world could see who had been “swimming naked”. Alan Greenspan, Ben Bernanke, and many economists claimed that “no one could see it coming”, but many economists working without the ideological blinders of mainstream economic theory did, in fact, see “it” coming.

Prominent among these economists is Jane D’Arista, whose prescient and insightful work on financial and monetary issues serves as a guide and inspiration for those who want to clear away the cobwebs of distorting economic ideology and, in the tradition of Keynes, Minsky and Kindleberger, sink their intellectual teeth into the real economic institutions and dynamics that drive our macroeconomy. If we do that, and ask how the dynamics and institutions of monetary policy, banking and financial regulation have evolved since Lehman Brothers, the panorama is astonishing.

Read rest here.

Banking, Monetary Policy And The Political Economy Of Financial Regulation

To be published soon. A Festschrift for Jane D'Arsita. From the dust-jacket:

"Jane D’Arista is one of those towering figures who thinks way ahead of the conventional understandings. A generation ago she recognized the distorted architecture of finance and banking and described in lucid detail the reform agenda for restoring a stable and equitable system. Written in the tradition of D’Arista, the essays in this important collection point the way toward overcoming the recurrent financial disorders of our gilded age. Like Jane D’Arista’s work, this timely volume demands the attention of both policy experts and the politicians who must do the reconstruction."

William Greider, author of Secrets of the Temple: How the Federal Reserve Runs the Country

For more info go here.

Gerald Epstein: Too-Big-To-Fail Advantage Remains Intact For Big Banks

Gerald Epstein:

Yeah, well, I think there are some noteworthy things. First of all, just to explain what this means, what it means is that these largest banks, like Bank of America, Goldman Sachs, JPMorgan, and so forth get an advantage when they borrow money in the financial markets, because the people who lend them money believe that if they get into trouble, the government will bail them out, that the taxpayers will bail them out. And this has been known since at least 1984, when Continental Illinois Bank almost went under and the government bailed them out, and then the government said, well, we're going to bail out the 11 biggest banks that are too big to fail, and we're going to bail them out in the future. And, of course, that's exactly what happened in the financial crisis of 2007-2008. So when investors lend money to these big banks, we've thought for a long time that they expect that they're going to get bailed out if they get into trouble, so they'll charge less money to these big banks...

Tokunaga & Epstein - Endogenous Finance of a Dollar-Based World-System: A Minskian Approach

Junji Tokunaga & Gerald Epstein 

From the Abstract:

Global financing patterns have been at the center of debates on the global financial crisis in recent years. The global imbalance view, a prominent hypothesis, attributes the financial crisis to excess saving over investment in emerging market countries which have run current account surplus since the end of the 1990s. The excess saving flowed into advanced countries running current account deficits, particularly the U.S., thus depressing long-term interest rates and fuelling a credit boom there in the 2000s. According to this view, the financial crisis was triggered by an external and exogenous shock that resulted from excess saving in emerging market countries, not the shadow banking system in advanced countries which was the epicenter of the financial crisis. Instead, we argue that a key cause of the global financial crisis was the dynamic expansion of balance sheets at large complex financial institutions (LCFIs)(Borio and Disyatat [2011] and Shin [2012]), driven by the endogenously elastic finance of global dollar funding in the global shadow banking system. The endogenously elastic finance of the global dollar contributed to the buildup of global financial fragility that led to the global financial crisis. Importantly, the supreme position of U.S. dollar as debt- financing currency, underpinned by the dominant role of the dollar in the development of new financial innovations and instruments, and was a driving force in this endogenously dynamic and ultimately destructive process.

Read rest here 

Gerald Epstein on why the Fed is pushing interest rates higher

Gerald Epstein

The quantitative easing is when the Federal Reserve essentially prints money and then buys Treasury bills and mortgage-backed securities and other things like that. And they've been doing about $85 billion a month and are now tapering--what they call tapering it down to $65 billion a month. And by doing that, they're putting less money and credit into the economy. And when there's less money and credit in the economy, that tends to raise interest rates. And hence you've seen a big shift in financial markets here in the U.S. and all over the world as a result of this expectation that both short-term and long-term interest rates are going to go up.

New Title: The Handbook of the Political Economy of Financial Crises

From the abstract:

The Great Financial Crisis that began in 2007-2008 reminds us with devastating force that financial instability and crises are endemic to capitalist economies that lack powerful and dynamically changing financial regulations that can keep the powerful forces of leverage and credit within sustainable bounds. Economists from Marx to Keynes, and Minsky to Kindleberger have well understood this profoundly important fact, yet the dominant mainstream economics of "rational expectations", "efficient markets" and "laissez-faire" that rationalized widespread financial liberalization and still dominates the economics profession has gotten it, literally, "dead wrong". The Handbook of The Political Economy of Financial Crises describes the theoretical, institutional, and historical factors that can help us understand the forces that create financial crises - with an emphasis on the crisis of 2007- 2008 - and the strengths and weaknesses of varying theoretical perspectives and policy approaches that have tried to comprehend and limit these financial tsunamis.

See more here.

NOTE: Although all of the chapters will be invaluable to the reader, one in particular that will be worth much perusing is by Prof. James Crotty on the irrelevance of efficient market hypothesis (EMH), which can preliminarily be seen here .

New issue of ROKE is now out

The new issue of the Review of Keynesian Economics, with papers by Jerry Epstein, Jane Knodell, Bill McColloch, Valerio Cerretano, Juan Matías de Lucchi and Esteban Pérez and an introduction by the President of the Central Bank of Argentina, Mercedes Marcó del Pont, is out. Papers have, for the most part, been presented at the central bank, and are on the issue of the role of central banks in economic development. Enjoy!

Jerry Epstein on the Argentinean Central Bank

Prevailing ideology has held that the only legitimate task for central banks is to control inflation, which often comes at the expense of broader goals such as employment creation, financial stability or economic growth. Now, in a bold and important move, the government of Argentina has fought against this neo-liberal “conventional wisdom” and broadened the mandate of the Argentine Central Bank to include economic growth and financial stability, and empowered it to use more tools to support credit allocation to promote productive investment and job creation (see Weeks).

Read the rest here (a slightly modified version published in Spanish by Página/12 here).

The political economy of the Euro crisis

The solution for the euro crisis seems increasingly out of reach. The victory of the conservative Popular Party in Spain, and the promise of more austerity, following the same in Italy and Greece, bodes badly for a more rational solution. Further, the German officials, and the ECB, in particular, its new head, Mario Draghi were very clear that they would not support anything but austerity.

A question that was raised in my talk last Friday was why would anybody favor such a suicidal policy. Think of the US for a second. Why would the Republicans play with the possibility of a self-imposed default (by not raising the debt-ceiling limit last summer)? The point is that the idea that there is a fiscal crisis (yep there isn't), would allow them (and some pro-business Dems too) to cut spending on welfare programs like Social Security and Medicare. And by the way, high unemployment helps to keep workers in line and wages low. The same is true in Europe.

A severe fiscal crisis, that forces adjustment in the periphery, helps to keep workers in line, not just in the periphery, but also in the core countries. And helps if they want to roll back their Welfare State too. Jerry Epstein says essentially the same thing here.

More fiscal stimulus or an Infrastructure bank?

In a recent LATimes op-ed Jamie Galbraith says that:

Federal budget deficits in this situation are like IV-bags in an emergency room: they stabilize things. IV's are definitely linked to sickness, and no one would use them if they weren't necessary. But very few doctors propose to cut back on saline while the patient is still sick. Today, however, the official economists and their followers in Congress, the White House and the media are divided between those who would remove the IV's slowly, whether the patient recovers or not, and those who'd like to charge through the wards, yanking needles from arms. The debt deal enacted earlier this month put the first group in charge, but that's pretty cold comfort.

The solution is not another "stimulus" — a term that stinks of needles and quick fixes. The solution has to be a long-term strategy: both a new direction for economic activity and new institutions to provide the money. The proposed national infrastructure bank — a permanent institution — is the right sort of thing and would be a good place to start.

Both the IV analogy, and the need for a radical departure from conventional solutions are right on the money.  I would add, however, that we do not need to wait for the infrastructure bank, since the Fed can and should do it.  As Jerry Epstein (2006) has shown, in the past central banks have provided subsidized credit for industrial activities, and have acted as agents of development.  So rather than wait for institutional innovation, current institutions can be put to work immediately.

It's the model stupid!

Brad DeLong, that together with Krugman has been a force for sanity within the mainstream, arguing for more fiscal expansion, shows why we need heterodox economists.  He says in a recent post:

This is a bad time to be an economist. If you were fresh from the womb and had no past opinions to defend, if you had never said anything notable before, it might be a fine time to be an economist. If you are one of those soap-opera characters who has complete amnesia and no memory of anything that they ever said or did or any intellectual position they took before January 1, 2010, it might be a fine time to be an economist. But for the rest of us--we who are now looking back at our opinions and analytic judgments and statements and pronouncements of the past 15 years and thinking: "how could I ever have been so stupid; how could I have missed so much?"--it is a bad time to be economist?

Four years ago we economists were writing learned papers about the "Great Moderation": about how it looked as though the governing institutions of the world economy had finally learned how to control and moderate if not completely eliminate the business cycle--the epileptic seizures of the economy that leave us with pointlessly high unemployment, pointlessly idle capacity, and pointlessly rusting away machines in spite of there being no fundamental cause for machines to be idle, factories closed, and workers unemployed.

Funny, I know of several economists that suggested that an economy based on debt-led consumption, on the basis of asset bubbles, was not sustainable and that a crisis was coming.  It would be tedious to cite all, and I'm lazy and don't want to find links to their papers, but a limited list of names (do a google search) would include Dean Baker, Jane D'Arista, Jerry Epstein, Jamie Galbraith, Wynne Godley, Thomas Palley, Bob Pollin and Lance Taylor (before hand I'm sorry for any significant omissions).  I knew enough to be sure that it was not sustainable.

But I'm glad that the best in the mainstream admit that it was stupid not to see it coming. I would suggest to him that part of the problem of the inability of the mainstream to see it coming is their theoretical framework.  The consensus macroeconomic model, based on an IS curve, a monetary policy rule, and a Phillips Curve with a natural rate of unemployment, in particular because it assumes that the economy automatically returns to the natural rate, is a flawed basis for understanding the real world.