The Light Dawns
A complete understanding of great events will often have to wait until well after the shouting and the tumult die away and a longer perspective permits a more objective assessment of what really happened. Even then, though, greater elucidation proceeds at a glacial pace.
Today, we may well find ourselves again at the beginning of just such a process. Just as it took a decade and a Second World War to achieve a broad consensus as to what had really caused the Great Depression in the 1930s, we can now begin to survey the events that led to the Global Financial Crisis, and the response that has been made by orthodox policy to the recession that followed, and to assess them in the light of the accumulating evidence of actual outcomes since those events.
The evidence is surely mounting that the remedies to recession proposed by orthodox policy have failed. The German insistence on austerity, smaller government and eliminating deficits has led directly to the travails of the euro zone and the real threat of renewed recession, with the result that countries like Greece and Spain are in desperate straits and the continued viability of the euro itself is at risk.
The British, despite all George Osborne’s chest-beating, have endured five years of austerity and the longest and deepest recession in modern times. Living standards have still not returned to pre-2008 levels and such prospects as there are for the future rest on an unsustainable consumer boom and asset inflation in the housing market.
The more moderate approach, the relaxed monetary policy and greater government involvement put in place by President Obama have produced, by contrast, at least a partial recovery in the American economy. The comparison compels conclusions that call into question the whole thrust of policy around the globe over the last three decades.
It is not just that neo-classical economics have failed to produce a solution to the problems created by the Global Financial Crisis. It is rather that the policies that were put in place before the GFC – and that we are now beginning to see were responsible for bringing it about in the first place – are now being pursued all over again, with every likelihood that they will produce the same outcomes.
The simple certainties that were the basis of the monetarist revolution that began in the 1980s – that national economies were just like private businesses, that there was little role for government, that the market could safely be left to produce optimal outcomes, that restraining inflation through controlling the money supply could and should be the only goal of macro-economic policy – are now being looked at in a different light.
The questioning is still piecemeal, still nibbling at the edges rather than constituting a full-scale assault, but there is no doubt that future historians will mark this decade as the point when the counter-revolution began. At the heart of that new thinking will be a re-assessment of what monetary policy is and should be about. Already, we see governments (for example, Shinzo Abe’s government in Japan), central banks (even the Bank of England, with New Zealand’s Reserve Bank deserving an honourable mention), and leading academic economists beginning to understand that a monetary policy instrument that is only ever used rather ineffectually to damp down asset inflation is absolutely missing the point.
That can be seen very clearly when we look again at the seminal paper published in the Bank of England Quarterly Review in March last year. That paper conceded (the first such concession made by any major central bank) that 97% of the money in the UK economy was created out of nothing by the banks; a similar proportion would be found in many western economies, including New Zealand.
The whole basis of monetarist policy was thereby revealed to be a charade. Governments may cut spending and impose austerity, and may raise interest rates in a vain attempt to control the money supply (while doing unnecessary damage in passing to investment in the real economy), but the banks go on printing money as though there is no tomorrow. The greater part of that new money is created – not for productive investment – but for house purchase, and all of it for private profit rather than the public good.
This huge increase in the volume of money, most of it directed into the housing market and unbacked by any corresponding increase in real production, has inevitably created a huge asset inflation, a dangerous bias in the economy in favour of speculation and against productive investment, a major driver of inequality between those who own property and those who do not, and an economic policy that is totally ineffective in the hands of governments that do not have the slightest understanding of what they are doing.
As for the banks, their profits soar, the bonuses they pay themselves multiply in size, and their ability to create wealth out of nothing means that the asset bubbles that eventually burst to bring about the Global Financial Crisis are again being inflated as we watch.
How did all this come about? The answer is simple. In the 1980s, financial services were deregulated, governments withdrew from macro-economic policy, banks moved in to displace building societies as the main suppliers of mortgage finance, restrictions on capital movements were removed. The result? The banks discovered that lending on house purchase was hugely profitable and almost risk-free, and that there was in practice no limit to how much money they could create; the only constraint was the presence or otherwise of willing borrowers. While governments strained every sinew to “control the money supply” and their own spending, the banks’ ability to create new money through the stroke of a book entry continued unabated.
A recent study by the National Bureau of Economic Research in the US of bank lending in twenty countries and over long periods shows an undeniable link between the increase in the money supply (though even these expert authors seem not to quite understand how that increase happens) on the one hand and asset inflation in the housing market and an increased risk of financial crises on the other.
The outcomes of this huge shift in economic power, away from governments and in favour of banks, are felt everywhere in our daily lives – in housing costs, in jobs, inflation, government spending, growth rates, balance of payments. Yet the change is hardly remarked, let alone understood. That is about to change – and not before time.
Bryan Gould
17 January 2015
“Disaster Capitalism” Is Alive and Well
It was the Canadian writer, Naomi Klein, who invented the term “disaster capitalism” to describe what she identified as a deliberate strategy to use the opportunity created by the shock of natural disasters, social dislocation or economic failure to force through “free-market reforms”.
She first recognised the phenomenon in the case of 1970s Chile under Pinochet, but there have been many instances since; societies suddenly confronted with unexpected crises have been forced, as the price of being bailed out by private capital or – just as commonly – by international agencies like the International Monetary Fund, to accept the prescriptions insisted upon by their supposed saviours.
The outcome in almost all such cases has been the adoption of “structural reforms” – a euphemism for asset sales, privatisation, deregulation and “free-market” economic policies which have done little to help the economies concerned but have provided rich pickings for powerful financial interests.
It may come as a surprise to some to realise that we have not been immune to such developments in New Zealand. The Christchurch earthquakes have provided just such an opportunity for the pursuit of objectives of a political rather than economic nature.
It was announced last week that the Christchurch City Council was about $900 million in the red, as a consequence of the reconstruction burdens it has had to assume as a consequence of the earthquake damage. The only solution, it is asserted, is that the Council must sell a large proportion of its existing assets, and it seems that – despite its long-standing opposition to such a course – the Council has reluctantly accepted its inevitability.
There are several reasons for regarding this as an instance of the “disaster capitalism” described by Naomi Klein. Such sales have been resisted by the Council in the past, as they usually are by most public authorities – and, in the case of our national assets, by most New Zealand voters – because they are seen to be bad business; they may seem to resolve a short-term problem but they ensure, through the loss of revenue-producing assets, a longer-term loss of major income streams and a consequent hole in the accounts which can only be made up by future generations of ratepayers or taxpayers.
The sale of assets is, however, very much welcomed by those private financial and commercial interests who see the chance of exploiting a short-term difficulty for their own private gain. The transfer of these assets into the private domain ensures that revenues that once went into the public purse will now be diverted into profits for a small group of shareholders.
Not surprisingly, the assertion has been eagerly welcomed by the city’s Chamber of Commerce; indeed, we are already told that the proposed sale of about a quarter of the Council’s assets will not be enough and will have to be followed by yet further sales.
Yet we might wonder why it is that the City Council is to be left alone to bear the burden of finding $900 million. Surely the cost of the damage caused by the earthquake disaster is on such a scale that the people of Christchurch cannot be left alone to meet it by themselves; and make no mistake, that is what they are being asked to do – every dollar of the revenue lost through asset sales will have to be covered by Christchurch ratepayers for years to come.
Rather than look for national solutions, such as the kind of credit creation for national purposes that we would naturally turn to in wartime, we are being asked to endorse a barely concealed step towards further privatisation. And bear in mind that Canterbury has already seen a similarly significant political development in the replacement of the Canterbury regional authority by a government-appointed board with a remit to ensure that water resources are made available, whatever the public interest, to allow for a major expansion of dairying.
Supposedly immutable economic factors, in other words, are being used to push through supposed and politically inspired “reforms”, based on “free-market principles” that are not supported by most New Zealanders. And, if we examine closely the government’s drive to cut public spending, we can see that the pattern is constantly repeated; it is often not just an economic outcome that is sought but a political one as well.
By putting public sector entities under financial pressure, for example, the government not only saves money but is able to force structural changes too – the tertiary education sector is a case in point. And the public purse can also be used to ensure that non-government bodies that might jib at complying with the government’s wishes can be kept in line – the Problem Gambling Foundation and Fish and Game are recent instances.
Paradoxically, this course is pursued at the very time that the government has had to step in to pick up the pieces of private sector failures like those of Novopay and the TV set recycling company RCN. The proper balance between public and private provision is not, it seems, as straightforward as the government seems to assume.
Bryan Gould
3 August 2014
Economics Students Demand Better
Economics students are revolting! No, not an admission from the teachers of economics that they find their students less than appealing, but a declaration of war by economics students across the globe who are fed up with the kind of economics they are taught.
Students in some of the world’s leading universities, including many UK universities, such as the London School of Economics, University College London, Cambridge, Essex, and Manchester, are leading the protest, and the campaign is now going worldwide.
Movements with similar goals have sprung up in the United States, Germany, France, Brazil, Chile, India and elsewhere (though not yet in New Zealand) and have organised a global alliance, calling themselves the International Student Initiative for Pluralist Economics. Students are flocking to this banner and hits on their website are growing exponentially.
The phenomenon has begun to attract attention from the economics profession. Two leading Cambridge economists expressed support for the campaign in an article in The Guardian last week; professional economists, agreeing that economics degrees are no longer “fit for purpose” and have little to do with the real world, have joined in.
What has prompted this revolt? The student protesters have noticed an obvious fact that seems to have eluded the wider economics profession. The economics that failed to foresee, much less understand, the Global Financial Crisis and the ensuing recession – the worst since the 1930s – is still being taught in our universities; students find it hard to believe that, despite those failures, the content of their courses has not changed in any way since 2008.
They are still being taught, in other words, an economics that depends largely on hypothetical postulates, expressed usually in mathematical terms. A number of assumptions are made – that consumers and investors, for example, all have equal access to perfect information, and act in a perfectly functioning marketplace.
On this basis, deductive logic arrives at economic models which appear to have great logical validity but which – as Keynes asserted – bear little relation to reality. The goal is not to explain the real world but to provide students with an analytical toolkit that allows economics to be treated as just as much a science as, say, physics.
This deductive and highly theoretical economics has dominated economic thinking over recent decades; it is in marked contrast to a quite different tradition, dating back to Adam Smith. This earlier approach derives economic conclusions from inductive reasoning based upon observed facts and detailed data analysis.
Adam Smith exemplifies this approach in The Wealth of Nations with his explanation of specialisation; he demonstrates, from his own observations, how a few specialised workers can create thousands of pins a day when one man on his own could hardly produce one pin per day. Keynes used a similar approach in reaching his conclusion that labour markets, left to market forces, do not produce full employment.
Today’s students have begun to realise not only that the deductive approach has been shown by experience to be deficient, but that there are many different approaches to economics, many of them better able to explain the real world and to guide policy. That is why they are calling for a more pluralist and open-minded approach to economic teaching and research.
Are they right and does it matter? Yes, because the theoretical deductive economics that is being taught to the exclusion of all else takes little account of how real people behave in response to economic stimuli; and this mistaken focus continues to produce mistaken policies.
A recent example of those mistaken policies is this week’s Australian budget. The Abbott government saw the chance to convince the Australian public that the economy is in worse shape than it really is and to use that as an excuse to push through “free-market” reforms. What they describe as “structural reform” is just code for a programme of privatisation, de-regulation, asset sales, lower wages, and public spending and benefit cuts – exactly the failed nostrums that the IMF used to propagate but is now backing away from and that have done such damage to the economies unwise enough to apply them.
Tony Abbott will nevertheless fancy his chances of convincing his voters that this is the right course because he knows that most of the opinion-formers and commentators on economic matters have been brought up on the same sterile doctrines. It is that closed mind – what the French call the “pensee unique” – that explains why public opinion, despite all the evidence to the contrary, is still easily persuaded that “there is no alternative” and that the economy is best managed by those who slavishly follow the current orthodoxy.
Our own government has of course applied the same policies – though not so blatantly and with greater subterfuge – and has also exploited the voters’ gullibility to persuade them that, as the Prime Minister claims, his government is “clearing up the mess left by Labour”.
We, at least, have the advantage of some strong-minded economics teachers in our universities who are ready to buck the trend; perhaps we can now look to our economics students as well to join the campaign for more open minds?
Bryan Gould
14 May 2014
The Bank of England Owns Up At Last
For those of us who have argued for a long time that orthodox monetary policy is fundamentally misconceived, a significant milestone was achieved this week. In an important paper published in the Bank of England Quarterly Bulletin*, three Bank of England economists have acknowledged that the overwhelmingly greatest proportion of money in the economy is created by the banks out of nothing.
This finding comes as no surprise to that growing number of economists and others who have recognised, as a consequence of simple observation, that this is the case. But it will no doubt be hotly denied, in the face of all common sense and evidence, by those (including bankers themselves) who, for reasons of self-interest or sheer ignorance, continue to adhere to the classical view that banks are simply intermediaries between lenders and borrowers.
The great British public is itself the victim of the confusion and obfuscation that has surrounded this issue for generations. Most people, if asked, will tell you that what the banks do is to lend out to borrowers the money that is deposited with them by savers. On this analysis, there is nothing particularly special about banks; they simply charge for the service they provide in bringing savers and borrowers together.
The truth, however, now conceded by the central bank, is very different. The banks enjoy a most spectacular and surprising monopoly power. They alone are able to create new money – vast quantities of it – by the stroke of a pen or, in modern terms, by pushing a key on a computer keyboard.
When a bank lends you money, it simply makes a book entry that credits you with an agreed sum; that sum represents nothing but the bank’s willingness to lend. The debt you thereby owe the bank does not represent in any sense money that was actually deposited with the bank or the capital held by the bank. Nevertheless, when it arrives in your account, and you use it to spend or invest, the overall money supply is increased by that amount.
The only attempt to regulate the volume of new money created by the banks comes through raising or lowering interest rates – a power exercised not by government but sub-contracted to – you’ve guessed it – another bank.
This means that, in practice, the only limit on bank lending is their willingness to lend to applicant borrowers at whatever the current rate of interest may be. The size of the market which provides the huge profits enjoyed by the banks is, in other words, decided by the banks themselves and their assessment of, and willingness to accept, the degree of risk involved.
There will, in the search for the ever higher profits to be made from lending more and more of the money which they themselves create, always be the temptation to lend more than is prudent in their own interests or desirable in the wider interest – and that is how the global financial crisis came about.
The astonishing feature of this monopoly power enjoyed by private companies seeking profits for their shareholders is that their decisions as to how much and for what purpose money should be created, made with virtually no external control or influence to restrain them, constitute by far the single greatest (and potentially distortional) influence on our economy.
The Bank of England paper has now laid all of this out for public inspection. The authors do not quite have the required courage of their convictions, since they attempt to downplay the significance of their conclusions by using the operations of a single bank to illustrate the process of credit creation, and thereby fail to register the immense scale, when looking at the banking system as a whole, of what they are describing. Even so, the policy implications of what they say are immense.
Our macro-economic policy at present is virtually limited to attempting to control the money supply as a means of regulating inflation. But since the volume of money is a function of bank lending and reflects nothing more than the banks’ search for profits at whatever the current interest rate may be, it follows that the whole thrust of current policy is entirely misplaced.
The banks, in deciding for themselves how much, to whom and for what purpose they will lend, will always give priority to lending for house purchase since it requires by far the least effort, and is the most secure and profitable form of lending. Can we be surprised that, as a result, those wishing to borrow for business investment are at the tail end of the queue while house prices – inflated by the volume of new money going into the housing market – go on rising inexorably?
It is bank-created credit that provides the major stimulus to asset inflation in the housing market, with all of its deleterious economic and social costs, while at the same time diverting essential investment capital away from where it is really needed – in the productive sector of the economy. If we wish to restrain inflation, why do we not target the most obvious cause, rather than burden the whole economy with deflationary interest rate hikes? And if we want a stronger real economy, why allow the banks the exclusive power to decide that the new money should go to housing rather than productive investment?
Our current monetary policy is based, in other words, on a complete misunderstanding of the role of money and its impact on economic activity. Our economy is awash with money, but it is neither the economically neutral phenomenon – interesting only because of its impact on inflation – that classical theory describes, nor does it provide the stimulus to new productive investment in the real economy that it could and should do.
Monetary policy need not be just a rather ineffectual tool for controlling inflation. It has the capacity instead to be a major stimulant and facilitator of real productive investment if we understand and use it properly. The banks’ monopoly of the power to create money prevents us from doing just that.
*Money Creation in the Modern Economy, by Michael McLeay, Amar Radla and Ryland Thomas.
Bryan Gould
22 March 2014
This article was published in the London Progressive Journal on 25 March 2014.
Live Mandela’s Principles In Our Own Society Today
The world’s response to the death of Nelson Mandela is a richly deserved recognition of the suffering and struggle he endured in defence of his principles, and the humility and magnanimity he showed when he finally achieved his, and his people’s, freedom.
He didn’t just proclaim his belief in human dignity, and his insistence that we are all equal in our humanity – he lived it. It is this shining example, this living embodiment of the quest for freedom and justice, that has touched so many people.
Nelson Mandela at least had the satisfaction of living long enough to see his life’s work vindicated, even by many of those who opposed him. It is a safe bet that a substantial proportion of those world leaders who paid him homage at Tuesday’s memorial service would not have given him the time of day when he was incarcerated on Robben Island; some, we are told, “can’t remember” what they thought of him at that time and others condemned him as a terrorist. The prospect of the presence of such people at his memorial service was an irony that was not, it seems, lost on Mandela himself.
But history is full of examples of brave men and women who stood against the prevailing tide – in other words, against the dominant power structures of the time – in order to stay true to the ideals of freedom, social justice and human dignity but, unlike Mandela, went to (or were sent to) their graves without ever seeing the fruits of their efforts. For many, it was only in death, and often much later, that their true worth, and the rightness of what they fought for, was recognised.
Mandela was, in this as in so many other respects, an exception to the general rule. While he himself was the first to recognise that his eventual triumph did not mean that South Africa became overnight the promised land (in economic terms at least), the outpouring of love and gratitude for what he had achieved shows how much the freedom from repression and injustice has meant to the people whose interests he served so faithfully. In his case, he was left in no doubt that freedom and justice – and the chance of a better life – mattered greatly to those who had been denied them.
So we must ask why so many of our leaders were so slow to value the universal issues that Mandela stood for and why even today we still resist them when they arise in our own societies and in our own times. Why is it that it is only when history and distance lend a longer perspective that understanding spreads as to the worth of what the champions of human dignity and equality – the fighters for the vote and the rule of law, the opponents of discrimination on grounds of race or gender or sexual orientation, the defenders of equal and basic rights for all – were trying to achieve?
Is it a failure of imagination? Are we are so comfortable in our easy lives that we cannot conceive that many people – even in our own country – are denied what we take for granted? Are we so persuaded by the constant propaganda that everything is fine that we close our eyes to the real lives of so many of our fellow-citizens? Instead of making the small effort needed to remedy the deficiencies, would we rather deny the facts or blame the victims?
What to make, for example, of the now incontrovertible evidence of the growing extent of child poverty in our supposedly prosperous society? Are we really prepared to dismiss the the Unicef finding that New Zealand is no longer a good place for children to grow up in or the report commissioned by the Children’s Commissioner that showed more than a quarter of a million children live in poverty?
At a meeting in Auckland last week, an American woman told me that, when she decided during the course of her first visit to New Zealand in the 1970s that she would settle here, her bewildered family back in the US asked her why. “Because here,” she replied, “there is enough for everyone.”
It is hard to think of a better definition of a society that functions well and successfully. So how did we become a society in which, despite our increased wealth, there is no longer enough for children who are brought up in cold, damp and overcrowded houses and have to go to school on empty stomachs? Why are we surprised that the illnesses of third world poverty are now rife amongst us and that our educational standards are slipping?
Will those who find it opportune to pay homage belatedly to the achievements of Nelson Mandela now bring that apparent conversion to bear in the here and now? Will they recognise and act on the claims of so many our children to an equal chance in our rich and beautiful land?
Bryan Gould
10 December 2013
This article was published in the NZ Herald on 11 December 2013