Marshall Auerback is a Fellow at the Franklin and Eleanor Roosevelt Institute. He has some 28 years experience in the investment management business, serving as a global portfolio strategist. Mr Auerback graduated magna cum laude in English & Philosophy from Queen’s University in 1981 and received a law degree from Corpus Christi College, Oxford University in 1983. He has contributed several articles to CounterPunch.
MIKE WHITNEY: In a recent article on New Deal 2.0, you offered an practical solution to growing unemployment: Make government the “Employer of Last Resort”. How would this work and who would be included? What effect would this have on the economy?
Marshall Auerback: What I am advocating would create something close to a full employment: a universal job guarantee available through the thick and thin of the business cycle. The federal government would ensure a job offer to anyone ready and willing to work, at the established program compensation level (including wages and a healthy benefits package). To keep it simple, the program wage could be set at the current federal minimum wage ($7.25 an hour) to minimize wage disruption, and then adjusted periodically as that is raised. The key is to get it entrenched as a permanent feature of government.
It would not be introducing another element of intrusive bureaucracy into our economy, but simply better utilizing the existing stock of unemployed…Social spending on the unemployed prevents aggregate demand from collapsing into a depression-like state, but little is done to enhance future growth and demand, which can be done by providing them with employment, greater education and higher skill levels.
The usual benefits would be provided, including vacation and sick leave, and contributions to Social Security. Although Hyman Minsky called this a “Government as Employer of Last Resort” idea, the phrase might be too emotive for some (many in this country have a visceral hatred of government), so let’s call it Job Guarantee (JG) program or an Employment Guarantee Act.
The original New Deal programs included large-scale infrastructure projects with direction coming from Washington. A permanent and universal JG program should be decentralized, with projects created and administered locally — where the workers are, and for the benefit of their communities.
This brings us to the fundamental principle of the Job Guarantee program: it is a complement that provides jobs to those who would otherwise be jobless and it provides public services and infrastructure that otherwise would not be supplied. JG workers will be gaining useful work experience and training, making them more appealing to other employers. When firms hire, they will recruit from the JG program, offering a slightly higher wage.
MIKE WHITNEY: Every day I get e mails from people who are worried that the US is sliding towards Zimbabwe-type hyperinflation. Since the financial crisis began, the money supply has exploded and the Fed’s balance sheet has widened to over $2.2 trillion. What effect will this have on the dollar and the US economy? Should we be concerned about Bernanke’s quantitative easing (QE) program?
Marshall Auerback: The only circumstances in which I could envisage a Weimar or Zimbabwe scenario is if we had complete political dysfunction and a corresponding loss of taxing authority, a la Zimbabwe (or the Confederacy during the Civil War). If the tax system breaks down, the government’s fiat money can indeed become worthless – which is manifested as hyperinflation. The government in that situation can print ever increasing quantities of money, but find little for sale, even as resources sit idle. This does not require full employment or high capacity utilization. In fact, quite the opposite because once the value of money collapses in the manner I described above, it becomes virtually impossible to undertake ‘money now for money later’ transactions, and the economy degenerates into barter, or the private sector contracts with alternative money with a relatively more stable value. The point is that that the hyperinflation is not caused by the “printing of money” per se. Rather, running the printing presses at full speed captures only the effect, not the cause of the problem. It is usually the breakdown of the tax system, indeed the political system as a whole, that creates the hyperinflation.
That is still an outlier in the US in my opinion, although watching our current government in action, I do not discount it as a possibility.
Quantitative easing is a crock. Let me quote our Federal Reserve chairman, Ben Bernanke: “Under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” But the government also has to know which buttons to press. QE and lower interest rates are not the buttons for that job. The button is the budget deficit, and they seem categorically against pressing it due to deficit myths.
Proponents of quantitative easing claim it adds liquidity to a system where lending by commercial banks is seemingly frozen because of a lack of reserves in the banking system overall. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system. That is an unfortunate and misleading representation.
The mainstream economists advocate QE once interest rates get down to zero because they see it as the only stimulatory monetary policy measure left. But their conception of the way the monetary system operates is flawed and also reflects their obsession with the use of monetary policy as a counterstabilising policy tool.
Modern monetary theory suggests that monetary policy will not be an effective instrument and QE in particular is a very long bow to draw if your objective is to stimulate economic activity.
Does quantitative easing work?
The mainstream belief is based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves.
This is the text-book conception of the world and parades as the money multiplier theory. It is taught – to their disadvantage – to all undergraduate students in economics. It is an exercise in deceptive brainwashing. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualization suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
But bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves. The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.
All that the central bank is doing is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the central bank). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.
In terms of changing portfolio compositions, QE increases central bank demand for “long maturity” assets held in the private sector which reduces interest rates at the longer end of the yield curve. These are traditionally thought of as the investment rates.
This might (but probably will not) increase aggregate demand given the cost of investment funds is likely to drop. But on the other hand, the lower rates reduce the interest-income of savers who will reduce consumption (demand) accordingly. How these opposing effects balance out is unclear. Clearly, the BOE research department has no idea of how the effects interact.
Overall, this uncertainty points to the problems involved in using monetary policy to stimulate (or contract) the economy. It is a blunt policy instrument with ambiguous impacts.
According to Bloomberg News, the Fed has committed or loaned over $11.4 trillion to stabilize the financial system. But very little has changed by way of regulation. In fact, capital requirements, securitzation, unregulated derivatives trading, and off-balance sheet operations, remain virtually the same. Aren’t we reassembling a system that we know has basic design-flaws? How do we fix this?
Marshall Auerback: Again, I think this misrepresents what the Fed has done. It’s been an asset shift. The Fed cannot create new net financial assets. Only the Treasury can do that. Instead, I tend to agree with Professor Perry Mehrling of Barnard College, who has argued, fairly convincingly in my view, that the expansion of the Fed’s balance sheet has been widely misunderstood within the economics profession, because it has been viewed through the lens of a pre-existing debate about the monetary transmission mechanism. Those who emphasized the importance of the money supply (on nominal spending) saw the expansion as quantitative easing, and warned about eventual inflationary consequences. Those who emphasized the credit channel (as Bernanke) saw the expansion as providing credit that was temporarily unavailable in the private market. The fact that the balance sheet expanded on both sides, and in both cases with the private sector as counterparty, tells us that something else was going on.
Instead, Mehrling has argued that the Fed’s actions after Lehman should be understood as moving the wholesale money market onto its own balance sheet. Banks with surplus funds lent them to the Fed by holding excess reserve balances, and banks that needed funds borrowed them from the Fed through the discount window. Foreign banks that needed dollar funding got it through their own central bank, which got it from the Fed through the liquidity swap facility. Banks that were short of collateral eligible for discount borrowed directly through the new commercial paper facility. Shadow banks that could not deposit in the Fed instead bought Treasury bills, and the Treasury deposited the proceeds at the Fed.
And, again, because we haven’t deployed our fiscal resources to support aggregate demand, the policies have not been successful. They are simply an attempt to restore a highly destructive status quo ante.
Economic growth in the US depends heavily on consumer spending. But for the last decade or more, workers’ wages have been stagnant, so growth has come from debt-spending. Now all that is beginning to change. Credit is getting tighter and households–that lost $13 trillion since the financial crisis began– have been forced to cut back. Is it really possible for GDP to increase without strong wage growth? How is widening inequality reducing aggregate demand and weakening the economy?
Marshall Auerback: This is not a new phenomenon. There is little understanding that if households and firms try to net save (save more out of income flows than they tangibly invest) incomes collapse, and desired private net saving is thwarted. The private “excess saving” cannot exist without a budget deficit or a trade surplus. Many people make this mistake. At best, we can talk about planned private saving being in excess of planned private investment, but other than that, we are violating double entry book keeping principles.
And consider this: in 1998, 1999 and 2000 (increasing each year), the US government “virtuously” ran budget surpluses. These were widely lauded even though they had the effect of draining aggregate demand and forcing the private sector to rely more on debt, the very things we are now rightly decrying. But we’ve misdiagnosed the cause. The fiscal surpluses caused the private sector to become more heavily indebted than before as the fiscal drag squeezed liquidity and destroyed aggregate demand and incomes. Along with our misconceived embrace of financial deregulation, the combined result was sharply rising unemployment and a major recession.
I would argue that we have the model from the FDR years. But this entails an approach where we work to restore personal incomes and balance sheets before we deal with the bank balance sheets. You improve aggregate demand and incomes will rise and with that so will CREDITWORTHINESS, as well as the ability to service existing loans. This in turn enhances the banks’ balance sheets and facilitates greater provision of credit. It’s so easy, even a banker can figure it out.
Today, I believe that most major banks are insolvent and cannot (and should not) be saved. Too big to fail means they are to big to be saved, although I think we have to approach this from the perspective of functionality as well as the sheer size of the banks.
We should insist upon a market structure in which financial institutions are universally small. But smallness cannot be defined by balance-sheet assets alone. We need to manage the degree of interconnectedness and the scale of total exposures (including off-balance sheet exposures arising from derivative market participation), which gets to your point about functionality. Further, we need to ensure that no market participants are indispensable by virtue of controlling some essential market infrastructure.
Right now it is essential that all big banks be examined during the “holiday” to uncover claims on one another. It is highly likely that supervisors will find that several trillions of dollars of bad assets will turn out to be claims big financial institutions have on one another (that is exactly what was found when AIG was examined—which is why the government bail-out of AIG led to side payments to the big banks and shadow banks). In addition, it will be necessary to increase supervision and regulation of the financial sector. It is particularly important to put a stop to the practices that brought on the crisis.
As the experience of the early 1930s as well as that of the 1980s tells us, if left alone to deal with the current problems, market mechanisms will push management and owners of insolvent institutions to ramp up losses. The result can be massive deflation, massive bankruptcies, massive destructions of physical assets, and enormous unemployment will continue until the debt structure is simplified. In the process, social unrest will grow to the point that the entire socio-economic system will be threatened.
A more effective way to restart the economic process on the solid ground is to deal with the underlying cause of the problem: borrowers cannot meet the required payments. This implies sustaining their income and employment and, if necessary, drastically modifying their debt service burden. The whole boom of the 2000s (and more broadly the growth process that emerged at the in the early 1980s) was based on household borrowing and the continuation of negative saving trends (that is, household deficit spending). A good place to start recovery efforts, therefore, would be to change this method of economic growth. There are two key ways to do that.
First, a household’s main source of income is its employment, which itself is heavily tied to the state of the economy. Policy can “decouple” this link to some degree through creation of counter-cyclical government employment programs. There are plenty of non-profitable, even though crucial, economic activities that require labor (from massive infrastructure programs to social services). CCC, WPA, and other programs of the New Deal employed millions of people, creating jobs very rapidly in extremely useful projects. In its first six years, the WPA spent $11 billion, three-quarters of that on construction and conservation projects and the remainder on community service programs. During that time, WPA employed about 8 million workers. The Civilian Conservation Corps (CCC) put approximately 2.75 million unemployed young men to work to reclaim government land and forests through irrigation, soil enrichment, pest control, tree planting, fire prevention and other conservation projects. Workers earned a dollar a day, and had to send part of their wages home to their families. Through the National Youth Administration (NYA) the government made it possible for 1.5 million high school students and 600,000 college students to continue their education by providing them with part-time jobs to meet their expenses.
Debt Jubilee 2010
However, guaranteeing access to employment will not be enough to deal with the current crisis. Indeed, following decades of growing debt, households have accumulated debt well beyond their means, and even if employment programs are put in place, they will pay on average a lower wage than what many jobless households used to earn. Given that many households could not service their debt with their previous income, providing them employment (at a wage that could be below their previous wage) will only provide some relief from their debt problem. We, therefore, need a massive modification of loans and possibility bankruptcy (which must be made simpler and less costly). Some economists, remembering that this was done in the past, have suggested a debt jubilee; credit card companies have already begun to go down this road and more could be done here. The government could provide incentives to encourage more financial companies to go down this path.
If borrowers can meet their payments, lenders will receive their funds and will return to profitability; in turn, some of the securitization processes will be revived. Of course, many banks are no longer used to making most of their money from interest payments, but it may be time to return toward a less trade-and-fee driven financial sector. Hold to maturity is a good starting point.
Marshall Auerback is a Fellow at the Franklin and Eleanor Roosevelt Institute. He has some 28 years experience in the investment management business, serving as a global portfolio strategist. Mr Auerback graduated magna cum laude in English & Philosophy from Queen’s University in 1981 and received a law degree from Corpus Christi College, Oxford University in 1983. He has contributed several articles to CounterPunch. He can be reached at be reached at [email protected]
MIKE WHITNEY lives in Washington state and can be reached at [email protected].