Monthly Archives: December 2009

“Fixing the Economy”

By Warren Mosler*

I was asked by a reporter to state how I’d fix the economy in 500 words and replied:

Fixing the Economy

1. A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%). This will restore ’spending power’ allowing households to make their mortgage payments, which ‘fixes the banks’ from the ‘bottom up.’ It also helps keep prices down as competitive pressures will cause many businesses to lower prices due to the tax savings even as sales increase.

2. A $500 per capita Federal distribution to all the States to sustain employment in essential services, service debt, and reduce the need for State tax hikes. This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP are restored.

3. A Federally funded $8/hr job for anyone willing and able to work that includes healthcare. The economy will improve rapidly with my first two proposals and the private sector far more readily hires people already working vs people idle and unemployed.
In 2001 Argentina, population 34 million, implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years 750,000 were employed by the private sector.

4. Returning banking to public purpose. The following are disruptive and do not serve no public purpose:

a. No secondary market transactions
b. No proprietary trading
c. No lending vs financial assets
d. No business activities beyond approved lending and providing banking accounts and related services.
e. No contracting in LIBOR, only fed funds.
f.  No subsidiaries of any kind.
g. No offshore lending.
h. No contracting in credit default insurance.

5. Federal Reserve- The liability side of banking is not the place for market discipline. The Fed should lend in the fed funds market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as the FDIC already regulates and supervises all bank assets.

6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than otherwise.


a. Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
b. Don’t tax the good banks for losses by bad banks. All that does is raise interest rates.

8. The Treasury should directly fund the housing agencies to eliminate hedging needs and directly target mortgage rates at desired levels.

9. Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the government at the lower of the mortgage balance or fair market value of the home.

10. Remove the ’self imposed constraints’ that are disruptive to operations and serve no public purpose.

a. Treasury debt ceiling- Congress already voted for the spending and taxes
b. Allow Treasury ‘overdrafts’ at the Fed. This is left over from the gold standard days and is currently inapplicable.

11. Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only to cool down an overheating economy, and not to ‘pay for’ anything.

*First published on

Fed Offers New CD; Chairman Bernanke is still confused

By L. Randall Wray

As reported in the NYT yesterday, the Fed has decided to offer banks an interest-paying CD. So far, so good. However, the argument offered by the Fed to justify this “innovation” is that it needs to start mopping up reserves in order to prevent inflation:

The Federal Reserve on Monday proposed allowing banks to park their reserves at the central bank, a move aimed at weaning the economy off extraordinary infusions of cash and curbing inflation. The Fed would create the equivalent of a certificate of deposit that pays interest to banks for keeping some of their reserves — which are currently estimated at more than $1 trillion — for up to one year. That would help offset some of the $2.2 trillion the central bank has fanned out into the economy during the financial crisis. It also would allow the Fed to quickly entice banks to take more money out of circulation in case inflation emerged as a serious threat in the near future. The proposal was the latest sign the Fed is intensifying its efforts to scale back the vast amounts of money it pumped into the economy at the height of the crisis.

This blog has published a number of pieces explaining why there is no need to worry about the trillions of dollars of reserves and cash created by the Fed to deal with the run to liquidity set-off by this crisis (see here and here). As and when banks decide they do not want to hold reserves, they will retire their loans at the discount window and will begin to purchase higher-earning assets. As this pushes up asset prices (reducing interest rates), the Fed will begin to unwind its balance sheet—selling the assets it purchased during the crisis. Retiring discount window loans plus purchases of assets from the Fed will eliminate undesired reserve holdings. It is all automatic and nothing to worry about or to plan for. And it will not set off a round of inflation. The old “money multiplier” view according to which excess reserves cause banks to lend, which induces spending, which causes inflation, was abandoned by all serious monetary theorists long ago. Chairman Bernanke ought to abandon it, too.

However, there is nothing wrong with offering longer-maturity CDs to replace overnight reserve deposits held by banks at the Fed. Banks are content to hold deposits at the Fed—safe assets that earn a little interest. They are hoping to play the yield curve to get some positive earnings in order to rebuild capital. If they can issue liabilities at an even lower interest rate so that earnings on deposits at the Fed cover interest and other costs of financing their positions in assets, this strategy might work. That is what they did in the early 1990s, allowing banks that were insolvent to work their way back to profitability. The Fed could even lend to banks at 25 basis points (0.25% interest) so that they could buy the CDs, then pay them, say, 100 or 200 basis points (1% or 2% interest) on their longer maturity CDs. The net interest earned could tide them over until it becomes appropriate for them to resume lending to households and firms.

Finally, note that these new CDs are equivalent to Treasuries: government debt that pays interest. However, no one has castigated the Fed for proposing to bankrupt our grandchildren by running up debt. Apparently, this is because economists and policymakers recognize that the Fed is just substituting one kind of liability (reserves) for another kind of liability (CDs). But that is exactly what a sale of a Treasury bond does: it substitutes one government liability (Fed reserves) for another government liability (Treasury bonds). Operationally, it all amounts to the same thing. Once this is recognized, the Treasury can stop issuing debt, we can all stop worrying about our grandchildren, and our nation can get on with ramping up fiscal policy to get out of this economic crisis.

A New Maestro?

By L. Randall Wray

Ok, the media is a poor judge of the performance of the Chairman of the Board of Governors. It seems like only yesterday that it anointed “maestro” status to Chairman Greenspan, right before all hell broke loose and he had to admit that his whole approach to financial markets had been dangerously wrong-headed. Now Chairman Bernanke is awarded with a magazine’s choice as “man of the year”—purportedly for saving capitalism as we know it. More importantly, the Senate is trying to decide whether he deserves reappointment. Usually these votes are little more than a rubber-stamping. Yet, something seems amiss this time around as the Senate Banking Committee voted 16 to 7 for approval—with significant opposition to reappointment. To some extent this is probably a vote of no-confidence for the Administration’s approach to dealing with the financial mess created by three decades of complete mismanagement of the banking system by a succession of Fed and Treasury officials. And, in truth, it would make more sense to fire Timmy Geithner and Larry Summers—who have done far more harm to the economy than has Ben Bernanke.

Let us suppose for a moment that Bernanke had done everything exactly right. Would he deserve accolades? In truth, the job of a Fed Chairman is pretty darn simple. So far as monetary management goes, he has one tool—the overnight interest rate target that is set in meetings of the Federal Open Market Committee. The Chairman has tremendous influence at these meetings, as we know from the transcripts that are released with a 5 year lag. While tremendous significance is believed to surround changes to the Fed’s target rate, in truth the overnight rate has little influence over the economy. As conventional thinking goes, the Fed raises rates in an inflation and lowers them in a recession. When the crisis hit, the Fed should have lowered rates, and did so. By itself, this should have had no impact; and by all accounts it had no impact. Should anyone receive man of the year designation for doing something that any Fed Chairman would have done, and which everyone agrees has virtually no impact?

Better to replace the FOMC with a rule that the overnight rate will be kept at zero from now on, a directive that the NYFed would implement. That would provide a lot more stability to the financial sector—and would go some way toward J.M. Keynes’s “euthanasia of the functionless rentier class”. But that is a story for another day.

In a crisis, the other thing the Fed does is to “provide liquidity”—that is, it lends reserves to prevent bank runs. This has been widely accepted policy since the 1840s and there is no central bank anywhere in the world that would not act as a lender of last resort in the sort of situation Bernanke faced. In fact, Bernanke was a bit slow to the gate on this, and never seemed to fully understand what he was doing. While he should have lent reserves without limit, to all comers, and against any kind of collateral, he played around with a variety of limited auctions, let a major financial institution fail due to lack of access to the Fed’s lending, and demanded good collateral for far too long. If anything, the Fed’s slow learning curve contributed to the crisis. Man of the year? I think not.

Finally, the Fed is supposed to be a regulator of financial institutions—through the thick and thin of the business cycle. Let us suppose a counterfactual: what if Bernanke had been a competent regulator from the time of his appointment? In truth, he consistently and persistently opposed any regulation that might have prevented this crisis, but in that he only followed his predecessor. And most of the damage had been done, with Greenspan at the helm since 1987 and with most of the important deregulation already accomplished by 2000. Clearly Bernanke deserves a grade of D- as a regulator (Timmy proudly earned an F when he testified before Congress that in all his years at the helm of the NY Fed he had never acted as a regulator!). So, he is certainly no worse than a Rubin or a Paulson and by 2005 when he was appointed he would not have had sufficient time or influence to overcome all the damage that had already been done. But a Man of the Year might have at least sounded a warning—rather than continually claiming even through summer 2007 that all was fine and dandy.

Bernanke will win reappointment. He has probably learned a bit as a result of this crisis so he will be a better head in his second term than he was in his first. Much is made of his scholarship that focused on the Great Depression. It is indeed a great advance over the work of Milton Friedman, who claimed the Fed caused the crisis by reducing the money supply. Bernanke also blamed the Fed for the initiation of the crisis, but the prolonged depression resulted because of the failure of financial institutions—which disrupted the relation between banks and their customers. When the bank of a farmer or entrepreneur failed, they were unable to borrow to finance operations—which collapsed production and employment. This is probably why Bernanke wants to prop up Wall Street institutions at all costs, to get “credit flowing again”. What he does not understand is that Wall Street banking has evolved—these are not lenders. They are speculators that serve no useful public purpose. If Bernanke were ever to figure that out, and would start to close down these predators, then he might deserve to be called Maestro.

“Man of the year”

By Warren Mosler

I’m perhaps a bit harsher and more direct in my criticisms than Time Magazine when they named Chairman Bernanke their Man of the Year:
His latest speech shows he’s got ‘quantitative easing’ and monetary operations completely wrong as he believes the banks lend out reserves.
His alphabet soup of programs for the interbank lending freeze up completely missed the point that all the fed has to do is lend in the fed funds market which would have immediately solved the problem that never should have happened, and lingered for over 6 months and contributed to the last leg of the collapse.

He’s on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term.

He’s on the wrong side of the trade issue, trying to engineer exports at the expense of domestic consumption, which is indeed happening, and causing our real terms of trade and standard of living to deteriorate.

He hasn’t even begun to consider the evidence that is showing lower rates to be deflationary rather than inflationary.

He still adheres to inflations expectations theory.

His unlimited dollar swapline program was an extraordinarily high risk policy that fortunately worked out, but never should have been done without discussion with Congress. In fact, last I read he still thinks it was low risk, not understanding that fx deposits at the foreign CB are not actual collateral.

If I had to select someone from outside the Fed for the next chairman Vince Reinhart is the only one I can think of that at least thoroughly understands monetary ops and reserve accounting, though we do have our differences on theory and policy.

*First published on

Who benefited, and by exactly how much?

UMKC’s Professor Bill Black joined Spitzer in calling for release of information on AIG’s operations and bail-out.

Many economists showing support by signing on to letter.

Some Things to Consider Before Reappointing Bernanke

By Eric Tymoigne

Chairman Bernanke has been praised for his handling of the crisis. Nobody disputes the fact that the massive emergency lending programs of the Federal Reserve helped to stabilize the financial system in the short-term; however, judging the first term of the Chairman purely on this ground is rather narrow minded.

It is important to remember that the preamble of the Federal Reserve Act lays out a dual mandate for the Federal Reserve System: (1) provision of “an elastic currency” and (2) “effective supervision.” While the former provides short-term stability in the form of a lender of last resort (during crises) and of a reliable refinancing channel for banks (in normal times), the latter is intended to promote long-term stability.

Unfortunately, supervision has always been seen as a secondary duty of the Federal Reserve System. The Fed, which is now overwhelmingly populated by economists (probably the least qualified to supervise banks), has too often ignored its dual mandate in favor of a single policy objective — managing price stability – which, importantly, was never the intended role of the Fed. Chairman Bernanke continues this tradition.

First, he (along with Governor Mishkin) is the main proponent of inflation targeting. Since 1999, he has been a strong advocate of purely focusing interest-rate settings on meeting an inflation target, while ignoring output growth and asset-price volatility. The models “showed” that price stability is the holy grail of policy goals that guarantees high (and stable) economic growth and financial stability. During his tenures as Governor and Chairman, this view has been at the core of his policy choices, and financial fragility has been largely left aside. Thus, from 2006, he continued Greenspan’s policy of raising policy rates to fight a presupposed looming “high” inflation, without any regard for an economy already extremely fragile. These policy actions contributed tremendously to systemic risk by pushing financial institutions and households into more leveraged positions (the worst mortgage originations occurred in 2005 and 2006, when the fed funds rate target was rising fast) and by creating large payment shocks on exotic mortgages. In addition, Chairman Bernanke did not consider the relevance of systemic risk until mid-2008, while many economists, journalists and bloggers from the financial community had been warning about the huge problems since 2005 at least.

Second, Chairman Bernanke has been a proponent of market-oriented regulation in the spirit of Basel II, and of the financial innovations that have been at the heart of the crisis. Mega financial institutions are supposed to know their business better and so, with some light oversight from the government, are supposed to be able to regulate themselves. Risk management, financial innovations and credit rating agencies are supposed to provide the proper signals and buffers against risks. This regulatory philosophy has failed miserably to prevent not only this crisis but also previous crises, and has contributed to growing financial instability over the past 30 years. In addition, the Federal Reserve has been unwilling to apply existing regulations to handle problematic banks and the Chairman has backed the shameless stress tests implemented under TARP. As Bill Black noted elsewhere, federal regulators are mandated to force recapitalization or to place in receivership insolvent institutions no matter how big they are. Receivership was done during the S&L crisis in a very smooth and competent way and it should be done today.

Third, the way the lender of last resort policy of the Federal Reserve has been implemented during the crisis has been flawed. The emergency lending programs have been highly opaque, creating suspicions of favoritism and unfair competitive practices. SIGTARP, US COP, and Bloomberg have been pushing hard for greater transparency (Bloomberg won a court battle but the Fed is now appealing). All those programs should have been done through the discount window, which should be destigmatized by making it the main way the fed intervenes on a daily basis.

Overall, Chairman Bernanke is not the right person to deal with the main concern that the Federal Reserve should, above all else, strive to maintain financial stability. Before the crisis, Chairman Bernanke ignored (or simply missed) the many warning signs until it was too late, and after the crisis he will likely return to his favored policy of targeting expected inflation.

One may wonder who the President should appoint as Fed Chairman. While I am not in the position to name anybody in particular, I can suggest some criteria. First, the Chairman should be a person who is old enough not to be concerned about finding a job once he or she leaves the Chairmanship. Second, she or he should be someone who is known for his or her independence of mind. Third, she or he should be someone that puts financial stability above all other criteria (because that is what the Fed was originally mandated to do and because it is the best way the Fed can promote price stability and stable economic growth). Finally, he or she should be someone who does not try to please the financial sector, and who involves much more other sectors of the economy in policy decisions.

The Lost Science of Classical Political Economy

By Michael Hudson

There is a seeming riddle in the recent evolution of economic thought. It has become more otherworldly and abstract, more detached from the reality of how economies are running deeper into debt to a financial oligarchy. The global economy itself is polarizing between creditor and debtor nations, financial core and periphery (even as the United States manages to play both sides of this street). Yet academic orthodoxy treats this as anomalous, side-stepping the two key features of today’s economic crisis: the “magic of compound interest” multiplying debts owed by the bottom 90 percent of the population to savers among the top 10 percent, while industrial capitalism is turned into a “tollbooth economy” by privatizing rent-extracting privileges on what used to be the public domain.

Academic rationalizers of today’s economic policy use models that deny that such as failure could exist in the first place. Yet mathematically inclined economists claim that their discipline has become a science. It may seem natural enough for the hallmark of science to be mathematics, but the real issue should not be universals but rather how nations are diverging economically and how this is a result of policy, not the presumably automatic workings of “free markets.” The mathematical boys confuse social sciences grounded in history and jockeying for political power with the universals of physics. We should be glad that they finally have dropped equilibrium theorizing, but game theory and chaos mathematics still do not address the key causal dynamics at work.

Pseudo-science wielded on behalf of special interests turns mathematical abstraction into a vehicle to strip away what used to be the major concern of classical political economy, and indeed economic reform, over the past two centuries. The aim of classical value and price theory was to isolate land rent, monopoly rent, and financial interest and fees (and “capital” gains) as a free lunch accruing to privilege.
Chicago School practitioners of free-market mathematics crow that “there is no such thing as a free lunch,” distracting attention from economic reality by dropping the history of economic thought and economic history itself from the curriculum. The very idea that there is such a thing as a free lunch is deemed heretical. This idea now governs academic departments and monopolizes the most prestigious economic journals, without publication in which it is difficult for junior faculty ever to rise to tenured positions in their universities. The aim is to censor the perception that today’s economy is all about getting a free lunch by obtaining legal privileges, as exemplified by the recent U.S. health care HMOs, the bailouts over banks deemed “too big to fail” and other beneficiaries of government largesse.

Most wealth through the ages has come from privatizing the public domain. Europe’s landed aristocracy descended from the Viking invaders who seized the Commons and levied groundrent. What is not taken physically from the public domain is taken by legal rights: HMO privileges, banking privileges, the rezoning of land, monopoly rights, patent rights everything that falls under the character of economic rent accruing to special privilege, most recently notorious in the post-Soviet kleptocracies, and earlier in the regions of the world colonized by Europe. (The word “privilege” derives from the Latin, meaning “private law,” legis.) These bodies of privilege are what make national economies different from each other.

Classical economists, the original “liberals”, were reformers with a political agenda. The “scientific” mathematizers seek to strip away their agenda, above all by exiling the analysis of rent extraction and special privilege to the academic sub-basement of institutionalism, claiming that a sphere of study that is not mathematized cannot claim the mantel of scientific method. The problem with this reactionary stance is that attempts to base economics on the “real” economy focusing on technology and universals are so materialistic as to be non-historical and lacking in the political element of property and finance. By the 1970s, for example, economic observers were talking about the convergence of the Soviet Union and America on the ground that each used virtually the same technology, along with Japan and Western Europe. For that matter, as early as the Bronze Age (3200-1200 BC) the economies of Mesopotamia (Sumer and Babylonia), Egypt, the Indus Valley and other regions all shared a similar technology, but each had entirely different economic and social systems. A “real” economic analysis focusing on their common denominators would miss the distinct ways in which each accumulated wealth in the hands of (or under the management of) a ruling elite different modes of property and finance, and hence with what the classical economists came to classify as “unearned income.”

Mathematizing economics and its claims to become a science overlooks these institutional differences, including the land rent and other revenue that John Stuart Mill said landlords made “in their sleep.” What this approach leaves out of account is the social policy wrapping for technology. If we lived back in 1945 and were told of all the marvelous technological breakthroughs of the past half-century, we would imagine that societies would now be living a life of leisure. Why has this not occurred? The reason is largely to be found in the predatory behavior that has enriched the finance, insurance and real estate (FIRE) sectors.

For classical and Progressive Era economists, the word “reform” meant taxing economic rent or minimizing it. Today it means giving away public enterprise to kleptocrats and political insiders, or simply for indebted governments to conduct a pre-bankruptcy sale of the public domain to buyers (who in turn buy on credit, subtracting their interest payments from their taxable income). The global economy is being “financialized,” not industrialized in the way that most economic futurists anticipated would be the case a century ago.
One would think that this should be the focus of economic theory and the mathematics it uses backed by appropriate statistical categories so that the mathematics would have something empirically quantitative as their subject matter, not merely Greek letters. That this has not occurred should throw the whole mathematical fad in question as being fundamentally dishonest and captured by the special interests. And this political use of mathematics merely as a rhetorical ploy should not be welcomed as science. It is simply deception.

The problem is not mathematics as such, but the junk economics and junk statistics used by the mathematicians who have captured the discipline of economics. For contrast, one need only turn to the 19th century’s rich toolbox of economic concepts developed to analyze today’s most pressing problems. What could be more relevant, for example, than the question of whether the exorbitant salaries and bonuses that bankers pay themselves are unfair, and how much they should fairly charge for their services? To answer this question the 13th-century Schoolmen developed the theory of Just Price. For the next six centuries down through the late 19th century, economists refined the distinction between technologically necessary costs of production and “free lunch” exploitation, using the labor theory of value to define intrinsic costs (reducible to labor, including that embodied in the capital goods and other materials used up in production) and the complementary concept of economic rent (unearned income above these costs, that is, market price less cost value).

To what extent does our burdensome and intrusive debt overhead grow faster than the economy¹s ability to pay, and what is the best policy to deal with excessive debts? Already in 1776, Rev. Richard Price dealt with the “magic of compound interest”, its tendency to grow exponentially (“geometrically”) while the economy grew at only simple (“arithmetic”) rates. This idea survives only in the form that Malthus borrowed in his 1798 population theory.

The overburden of public debt prompted Adam Smith to comment that year that no government ever had repaid its debts, and to propose means to keep it in check by freeing the American colonies that were a major source of conflict with France, for instance, and most of all, by paying for wars out of current taxation so that populations would feel their immediate cost rather than running into debt to international bankers such as the Dutch. Interest on Britain’s public debt absorbed three-quarters of its fiscal budget after the Napoleonic Wars. Writers such as Malachy Postlethwayt analyzed how this debt service added to the cost of living and doing business. His logic along these lines is part of the lost science of classical political economy.

The early 19th-century French reformer St. Simon proposed that banks shift from making straight interest-bearing loans to “equity” loans, taking payment in dividends rather than stipulated interest charges so that debt service would be kept within the means to pay. (Islamic law already had banned interest.) This became the inspiration for the industrial banking policies developed in continental Europe later in the century. St. Simon influenced Marx, whose manuscript notes for what became Vol. III of Capital and Theories of Surplus Value collected what he read from Martin Luther to Richard Price on how debts multiplied by purely mathematical laws independently of the “real” economy¹s ability to produce a surplus. The classical concept of productive credit was to provide borrowers with the means to pay. Unproductive debts had to be paid out of revenue obtained elsewhere.

This distinction threatened the financial sector’s option of making unproductive loans. More congenial were the Austrian School and marginal utility theorists who depicted debt as a voluntary trade-off of present consumer utility (“pleasure,” not need) for future income that presumably would rise, thanks to the prosperity brought in the train of technological progress. Interest paid by consumers was treated as a psychological choice, while industrial profit was treated as a return for the widening time it presumably took to produce capital-intensive goods and services. The ideas of “time preference” and the “roundabout” cycle of production were substituted for the simpler idea of charging a price for credit without any out-of-pocket cost or real risk undertaken by bankers. The world in which economic theorists operated was becoming increasingly speculative and hypothetical.

Financial analysis turned away from viewing interest as a form of economic rent income achieved without a cost of production. After the Napoleonic wars ended in 1815, Britain’s leading bank spokesman, David Ricardo, applied the concept of economic rent to the land in the process of arguing against the agricultural tariffs (the protectionist Corn Laws) in his 1817 Principles of Political Economy and Taxation. His treatment deftly sidestepped what had been the “original” discussion of rentier income squeezed out by the financial sector.

Should Ben Bernanke be retained as Fed Chairman?

This week, we will be running a series of essays on TIME Magazine’s ‘Person of the Year’, discussing whether he deserves to be reappointed as Chairman of the Federal Reserve. The first of these installments – posted below – comes from Marshall Auerback. Tomorrow’s installment comes from Warren Mosler.

Why Bernanke Must Go

By Marshall Auerback

There are any number of reasons why Ben Bernanke should not be reconfirmed, notwithstanding the vote in his favor by the Senate committee last week.

1. Let’s start by using some criteria laid out by Bernanke himself. When first nominated as chairman of the Federal Reserve, Mr. Bernanke promised a greater degree of transparency than his predecessor, but has completely stonewalled anybody seeking to obtain clarification of the events surrounding the credit crisis and more specifically, the role of the Federal Reserve. Any information disclosed would have facilitated a proper assessment of Bernanke’s job performance (which is probably one of the reasons the Fed chairman doesn’t want it released) and, more importantly, would have created a foundation for useful forensic work to prevent recurrences going forward.

Understanding what the decision-making was prior to and during the crisis is key to evaluating Bernanke’s performance and to improving performance in general. Post mortems are standard in sports and medicine. Why not here? And, more importantly, why does Bernanke continue to oppose it? Even the Swiss National Bank has provided a higher level of disclosure and transparency on the banking crisis to its public than has hitherto been agreed by the Bernanke Fed.

2. The Fed chairman claims unique expertise on the grounds of his scholarship of the Great Depression. Few have actually challenged him on the basis of these academic credentials, yet Bernanke holds these out as if they are manifest proof of his appropriateness for the position as head of the Federal Reserve. Ironically, even though Bernanke drew heavily on the work of both Milton Friedman and Anna Schwartz for his own scholarship of the period, Ms Schwartz herself has been enormously critical of the Fed’s conduct both pre-crisis and in seeing providing liquidity as the primary solution. She also warned explicitly against drawing comparisons between the gold standard era Depression and now. Additionally, Bernanke’s reading of the Depression (which is pretty conventional, that the Fed blew it by not providing more liquidity) ascribed little significance to fiscal policy, which has led Bernanke toward wrongheaded “solutions” such as “quantitative easing” and an alphabet soup of lending facilities, none of which did anything to enhance aggregate demand. Consistent with that, the Fed chairman been on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term, which suggests that he learned nothing of the fiscal successes of the New Deal.
3. Bernanke’s consistent advocacy of “quantitative easing” perpetuates the silly notion that the Fed has had something to do with the economic “recovery” (a line which Time Magazine had readily embraced in its selection of the Fed Chairman as “Person of the Year”). He has ascribed little importance to the existence of the automatic stabilizers and indeed has persistently fed the misguided notion that the Federal government had limited fiscal resources.

The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment. But as Bill Mitchell as pointed out, quantitative easing merely involves the central bank buying longer dated higher yielding bonds in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts: “[QE] 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.” In the real world, the creation of a loan and (concurrently) a deposit by a bank are in no way constrained by the quantity of reserves. Instead, the terms set by the central bank for acquiring reserves (which then also affects the rates banks borrow at in money markets) affect a bank’s profit margin on a newly created loan. Thus, expanding its balance sheet can create a potential short position in reserves, and thus the profitability of newly created loans, not the bank’s ability to create the loan.
Banks, then, lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. Even the BIS recognizes this. Unfortunately our Federal Reserve chairman either does not know this (in which case his ignorance disqualifies him for another term in office) or he deliberately misrepresents the actual benefits of QE (duplicity being another good ground for disqualification for a 2nd term). The current incoherence of our economic policy making could diminish if we had a Fed chairman who understood the importance of fiscal policy, rather than one who downplays its significance. Which leads to point 4 below.

4. The Fed chairman continues to demonstrate a tremendous conceptual confusion at the heart of the current crisis, particularly in regard to the banking sector. He actively supported TARP on the grounds that repairing the banks balance sheets would somehow “unblock” credit flows and thereby enhance economic activity. The whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. This will never happen as long as this apologist for Wall Street remains head of the Fed. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by, amongst others, the Federal Reserve Chairman.
For all of these reasons, Bernanke must go.

Michael Hudson Responds to Paul Krugman

By Michael Hudson, Distinguished Visiting Professor, UMKC

I have recently republished my lecture notes on the history of theories of Trade Development and Foreign Debt. (Available from Amazon) In this book, I provide the basis for refuting Samuelson’s factor-price equalization theorem, IMF-World Bank austerity programs, and the purchasing-parity theory of exchange rates.

These ideas were lapses back from earlier analysis, whose pedigree I trace. In view of their regressive character, I think that the question that needs to be asked is how the discipline was untracked and trivialized from its classical flowering? How did it become marginalized and trivialized, taking for granted the social structures and dynamics that should be the substance and focal point of its analysis? As John Williams quipped already in 1929 about the practical usefulness of international trade theory, “I have often felt like the man who stammered and finally learned to say ‘Peter Piper picked a peck of pickled peppers’ but found it hard to work into conversation.”  But now that such prattling has become the essence of conversation among economists, the important question is how universities, students and the rest of the world have come to accept it and even award prizes in it!

To answer this question, my  book describes the “intellectual engineering” that has turned the economics discipline into a public relations exercise for the rentier classes criticized by the classical economists: landlords, bankers and monopolists. It was largely to counter criticisms of their unearned income and wealth, after all, that the post-classical reaction aimed to limit the conceptual “toolbox” of economists to become so unrealistic, narrow-minded and self-serving to the status quo. It has ended up as an intellectual ploy to distract attention away from the financial and property dynamics that are polarizing our world between debtors and creditors, property owners and renters, while steering politics from democracy to oligarchy.
Bad economic content starts with bad methodology. Ever since John Stuart Mill in the 1840s, economics has been described as a deductive discipline of axiomatic assumptions. Nobel Prizewinners from Paul Samuelson to Bill Vickery have described the criterion for economic excellence to be the consistency of its assumptions, not their realism.[2] Typical of this approach is Nobel Prizewinner Paul Samuelson’s conclusion in his famous 1939 article on “The Gains from International Trade”:

“In pointing out the consequences of a set of abstract assumptions, one need not be committed unduly as to the relation between reality and these assumptions.”[3]

This attitude did not deter him from drawing policy conclusions affecting the material world in which real people live. These conclusions are diametrically opposed to the empirically successful protectionism by which Britain, the United States and Germany rose to industrial supremacy.

Typical of this now widespread attitude is the textbook Microeconomics by William Vickery, winner of the 1997 Nobel Economics Prize:

“Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them… The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world. A theory as an internally consistent system is valid if the conclusions follow logically from its premises, and the fact that neither the premises nor theconclusions correspond to reality may show that the theory is not very useful, but does not invalidate it. In any pure theory, all propositions are essentially tautological, in the sense that the results are implicit in the assumptions made.”[4]

Such disdain for empirical verification is not found in the physical sciences. Its popularity in the social sciences is sponsored by vested interests. There is always self-interest behind methodological madness. That is because success requires heavy subsidies from special interests, who benefit from an erroneous, misleading or deceptive economic logic. Why promote unrealistic abstractions, after all, if not to distract attention from reforms aimed at creating rules that oblige people actually to earn their income rather than simply extracting it from the rest of the economy?


[1] John H. Williams, Postwar Monetary Plans and Other Essays, 3rd ed. (New York: 1947), pp. 134f.

[2] I have surveyed the methodology in “The Use and Abuse of Mathematical Economics,” Journal of Economic Studies 27 (2000):292-315. I earlier criticized its application to international economic theorizing in Trade, Development and Foreign Debt (1992; new ed. ISLET, 2009), especially chapter 11.

[3] Paul Samuelson “The Gains from International Trade,” Canadian Journal of Economics and Political Science, Vol.  5 (1939), p. 205.

[4] William Vickery, Microeconomics (New York: 1964), p. 5.