Austerity: the Political Struggle over Who Controls the Economy’s Liquidity

By Michael Hoexter

The austerity campaign, a favorite for the last four years of politicians and financial tycoons, remains a seemingly self-contradictory and baffling phenomenon for those who know that it goes against at least 80 years of economic wisdom regarding management of the economy.  The campaign draws on irrational strains and inconsistencies in our economic self-understanding to turn politicians against the welfare of society and the economy as a whole as well as against their own interests as political leaders.  Austerity appears to serve the perceived short-term interests of some sectors of the wealthy and the financial industry but the long-term interests of no one. 

The question remains, if no one’s longer term interests are served by austerity, why is austerity being pursued, other than to satisfy the short-term greed of the few?  Beyond the obvious massive legalized corruption of our political system which is its most immediate support, there may be a parsimonious way to explain the design of the austerity campaign that goes beyond, though does not dispense with, moral condemnation and greed.  The austerity advocates’ eagerness to “grind the face of the poor [ and the face of pretty much all of society] into the dust” is not explained alone by a call to extraordinary (though likely) moral turpitude and lust for lucre.  There are other expressions of greed and sociopathy that do not take the form of enthusiasm for austerity.  For instance selling toxic mortgages or committing other forms of fraud are equally signs of amorality or immorality: why does this form of moral turpitude take the shape that it does?

I believe austerity can be best understood as a titanic political-economic struggle over who controls macroeconomic liquidity as well as a struggle over the future of the private banking industry.  In this struggle any number of ruses and confusions are used to hide the true nature of what is at stake from the public, which otherwise would run the advocates of austerity out of town if not sue them within an inch of their lives.

Two Ways to Adjust Macroeconomic Liquidity

There are two great controls that adjust the liquidity of the modern economy.

One method to adjust the economy’s overall macroeconomic liquidity is the operations of the central bank in setting interest rates and supporting banks in making credit available to consumers, local governments, other financial institutions, and businesses.  This is called, somewhat misleadingly, “monetary policy” which encompasses interest rate policy and inflation targeting by the central bank; it perhaps should be called “private lending policy” or “private bank policy”.  If the banks do not see profitable opportunities to lend money, what emerges is the so-called “liquidity trap” observed first by Keynes, which one encounters when the economy is in a debt-deflation, when low interest rates do not promote business activity due to many potential borrowers with too much debt and reduced incomes.  

The other, more complex method to adjust macroeconomic liquidity is fiscal policy, which is as much a monetary policy as is the central bank management of the private lending system.  Fiscal policy as monetary policy encompasses the spending and taxation policies of the national government, in the case of the US, the US Federal Government.  The monetary effects of fiscal policy are often a byproduct of the government fulfilling its mission to fulfill the public purpose however that may be defined by the political process.  The government may design its fiscal policy more or less with that policy’s monetary effects in mind depending in part on the orientation of the government as well as the state of the economy at a particular point in time.  

Despite the attention given to strictly monetary policy by economists and economic policy makers, it is fiscal policy that has the greatest long-run effect on the growth of the economy in the middle and longer term.  As has been discovered by Modern Money Theorists, the cumulative deficit spending of government, the net injection of currency into the economy by government, enables overall private sector growth and savings in monetary terms, especially in economies with a current accounts (trade) deficit.

By contrast, the private lending cycle has a net subtractive effect on monetary growth, the liquidity and potential liquidity, of the economy averaged out over the business cycle.  The benefit of private lending into the real economy is that real assets like housing and factories are created, many of which are quite useful or desirable to individual or business participants in markets.  Loans must however be repaid with interest, so the net wealth of the financial sector from interest payments or fees actually subtracts from the liquidity of the real economy.   In order for interest to be paid the money for interest payments in net across the entire economy must be injected into the real economy from government spending in excess of taxation. The private banking sector cannot, in accounting terms, afford to give away its loan principle (even though this is created out of thin air) because it would otherwise show a loss on its balance sheet.  A monetarily sovereign government’s deficit spending remains the net contribution of government to monetary growth.

Via Austerity, the Liquidity Merchants Attempt to Control Their “Competition”

After the global financial crisis of 2007-2008, the banks and financial intermediaries who were the proximal causes of that crisis were able to avoid a restructuring of the world’s financial systems similar to what occurred after the last Great Crash of 1929.   These private financial institutions are the pro-cyclical liquidity merchants whose lending can accelerate upturns and exacerbate downturns in the business cycle via the search for profitable ways to lend money and efforts to recover loan principle plus interest.  Benefiting from bank-friendly ideology in the halls of government and some quick maneuvering, the large banks were bailed out and only a small minority of governments (Iceland stands out) attempted a complete overhaul of the overgrown financial system.  Huge mountains of private debt remained and weighed down ordinary people, leading to anemic effective demand.

Rather than a revival of pro-Keynesian sentiment in the capitals of the world, agents of the financial industry along with habitual anti-Keynesians on the Right were quick to reactivate prejudices against government intervention in the economy, even as many of them had just been financially rescued by such intervention.   Within the dominant neoliberal philosophy, buttressed by an “Austrian”-influenced neoclassical economics that has been politically fashionable for three decades, government intervention in the economy had been viewed as a malaise or a sin which must be atoned.  The financial industry and its cheerleaders in the press jumped upon flaws in the undoubtedly flawed bailout and stimulus packages enacted by government to spur on a “Tea Party” movement against government as a manager and rescuer of the economy.  The drive towards austerity contradicted empirical evidence about the role of government after a financial crisis but this did not matter to the ideologically-driven campaign to blame government intervention and throttle government as a force in the economy. Within the prevailing neoliberal paradigm, debate was shoehorned into a “whether or not government” rather than a “how to best use the instrument of government” political debate.

The austerity drive and the longer-term drive to try to cut government social spending programs, have been spearheaded for the most part by the financial sector as it has grown in size and influence.  In the United States, Wall Street billionaire Pete Peterson, a habitual anti-Keynesian, has been the chief organizer and campaigner for austerity, or, within his own paradigm “balanced budgets” or “fiscal responsibility”.  While there are vertically integrated campaign organizations led by representatives of the FIRE sector (like Third Way, the Concord Coalition) with former Treasury Sec’y Robert Rubin involved in more than one and funders like Peterson, one does not need to have a “single mover” or conspiracy theory of the austerity drive to understand that the financial sector would have an interest-based antagonism to the “other” great control of economic liquidity, government fiscal policy.   Increased use of the fiscal policy as opposed to monetary policy makes the real economy less dependent on the vagaries of private finance, on commercial and consumer loans, to achieve economic goals.  The government through direct spending and provision of insurance, becomes a bank and insurer, in many sectors more effectively than private banks and insurers. 

A financial industry with the pretension to control, directly and indirectly, the monetary system will then have an “intuitive” attraction to fitting a straitjacket around its chief rival, the spending and taxation policies of government, which could be tightened and loosened according to the financial industry’s whims and needs rather than the needs of the real economy and the society at large.  This requires, of course, a compliant governing class, bought and sold by campaign contributions, donations to sympathetic non-profit organizations, emoluments and lobbying positions in semi-retirement, and luxurious retreats, all of which are affordable by the financial industry plutocrats.

Vigorous critics of austerity, who are still on the margins of political debates in the US and Europe, have long pointed out that austerity’s laming of fiscal policy has created a larger political and economic space for maneuver for banks and financial industry representatives.  In the United States, the most obvious examples are the cutting of public insurance and pension programs, which obviously create a larger market opportunity for FIRE sector products that are riskier and offer less for more expenditure.  Thus the low-cost liquidity offered by government is substituted by a higher cost and potentially bankrupting liquidity offered by private finance.

The convenience of this arrangement is ideal for the financial industry which can have its government minions take direct responsibility for the potential failings of either fiscal or monetary policy while still indirectly controlling them by creating an ideological atmosphere where those political leaders essentially do the bidding of the financial industry.  The ideological framework of austerity and the government- and public debt- phobia upon which it is based, initiates an almost inevitable push towards laming fiscal policy, which in turn as government becomes underfunded and less effective creates a self-fulfilling prophecy that government is fallible and private finance becomes viewed as preferable or “less worse”.

Public Control of the Monetary System to Serve the Public Purpose

There is a slight ebb in enthusiasm for austerity in the last month in both Europe and the US.  The mea culpa of the IMF chief economist and the stream of reports of a recession in many European countries after the implementation of austerity policies have finally dampened the enthusiasm for austerity that had seemed immune to falsification by real world data.  The news that the net contraction of the US economy in the fourth quarter of 2012 was directly related to reduced government spending is another obvious and ominous sign that arbitrary cuts in federal spending are foolish.

Despite these retreats from fervid insistence on austerity as the only conceivable alternative, the set of beliefs that underlie austerity are still treated as common sense in the capitals and media centers of the world.  Politicians still claim virtue by cutting government’s expenditures and by claiming present or future deficit reductions.   Government is still discussed as an expendable part of the social fabric as well as dispensable in the day to day and long-term functioning of the economy. There is a fundamental lack of understanding of government’s vital role in sponsoring economic growth and government’s ability to look beyond the concerns of market participants towards fundamental issues of law, ethics and sustainability.

As the above description of the two methods to control macroeconomic liquidity suggests, government’s fiscal policy is the long-term sponsor and controller of growth as well as the most effective tool to steer the economy away from catastrophes like climate change, the gravest challenge now facing humanity.  While our current monetary policy starts with the adjustment of private lending, we really should focus on fiscal policy first as the foundation upon which adjustment of private lending takes a secondary role.   Dan Kervick, recently, has outlined, as is implied by Modern Money Theory, that fiscal and monetary policy should be integrated into the same institution:  a Treasury department that encompasses the functions of the current Federal Reserve Bank and the current Treasury.  He argues against the lore that an independent central bank is somehow a neutral arbiter of monetary policy, which in the case of the US Federal Reserve, is actually owned by the large commercial banks.  This Treasury department would respond to the dictates of Congress and the President with regard to how to manage the combined monetary and fiscal policy of the United States.  The President and Congress in turn would respond to the demands of the American people for pressing economic issues to be addressed.

Regarding the “serious” preference for discussing the arcana of central bank policy, the private financial system and its apologists within the economics profession cannot have it both ways:  be viewed as neutral, apolitical guardians of people’s wealth while controlling the political process with regard to all matters financial, public and private.  The requirement that bankers lend with the expectation of receiving interest payments or collect earned and unearned intermediation fees as income makes their neutrality in matters financial worthy of scrutiny.  Via the austerity campaign and the hard-money myths about money that it purveys, the emerging financial oligarchy wants to control both types of macroeconomic liquidity for its own private benefit.  This formation of a financial oligarchy which has encircled Washington would be completed by adopting the principles of the austerity campaign as the ruling principles of government finance.

The alternative then is for there to be transparent public, democratic control over macroeconomic liquidity, to allow ordinary people to fully participate in the economy.  Such control would also tend to orient economic outcomes to benefit society as a whole and also work towards its sustainability.  While the public monopoly of the currency already exists in the US and many other countries, fully public and democratic control of the liquidity system requires a number of steps in order for it to occur in a way that is optimal for the economy as a whole and for the continuance of human society.  We are currently at a state of very poor understanding by the public and political leaders of how the economy really works; especially as regards the role of government both in the area of money as well as understanding the nature of markets and their limitations.  Furthermore the forces that are pushing for monetary reform are marginalized and do not have a unified set of demands around which to organize support for reform and attract media attention.

Here provisionally is the start of a list of objectives that should be achieved if assertion of public control of the monetary system is to occur and be successful:

1)    Monetary reformers associated with MMT and other closely related movements and economic schools would need to agree on a “minimum mandatory” and generate a range of “optimal” sets of policy recommendations for the institutional and procedural form of sovereign government monetary policies.  Among other issues to be determined, what role is there for sovereign bond issue in a fiat currency regime, what is the relationship of the central bank to the Treasury, etc.

2)    Economists along with affiliated social and natural scientists would need to develop a set of “minimum mandatory” and “best practices” analyses of the macro-economy that might be called “macroeconomic accounting”.  This would formalize the guidelines for controlling liquidity in the economy via a combined fiscal and monetary policy.  Some of these analyses are already executed by various government agencies and the Federal Reserve but are not formalized by economists into a set of decision support tools for policymakers, i.e. macroeconomic accounting. Parameters of the economy that these tools would analyze include:

  1. Appropriate Accounting (Nomenclature and Numerical Representations) of Monetary Operations of Monetarily Sovereign Governments (similar similarities and differences with business and household accounting) e.g. can “deficits” within national currency exist?  Is a balance sheet the correct accounting format?
  2. Unemployment
  3. Inflation
  4. Exchange Rate Regime
  5. Balance of Trade
  6. Sovereign Debt Issuance and Management
  7. Carbon Footprint
  8. Ecological Footprint
  9. Energy Intensity
  10. GDP and Alternatives to GDP
  11. Material Sustainability (Water, Waste, Food Production)
  12. Measures of Health and Well-being

3)    a persuasive public education program with accessible non-technical presentation would need to be implemented targeted at both politicians and the general public

4)    some majority of the public and/or the political class itself would need to agree as a matter of principle and practice that the public good, as represented by a “good-enough” government, takes precedence over private interests, contradicting 35 years of neoliberal propaganda, that suggests that private interests are infallible.  From this stems once again the legitimacy of government to enforce laws and institute regulation of private interests for the common good.

5)    The financing of the electoral system would need to be freed from the influence of moneyed private interests, with either entirely public finance of the electoral process or rigid limits to donor spending within the means of median income individuals and families.

6)    The private financial system would need to be restructured in order to be subordinated to the public good and to serve the functioning of the real economy, as happened in the United States in the 1930’s.  There are a number of approaches to this large task:

  1. Systemically dangerous institutions that can blackmail government would need to be broken up into smaller banks.
  2. Private banking would become a (more) highly regulated public utility
  3. A public banking system could be founded to provide banking functions as a public service to compete with or in some cases replace private banking
  4. Fraud and the legitimate functions of the banking system would need to be clearly defined and enforced.
  5. Some combination of the above measures

While “outsourcing” the management of money to the financial industry has allowed many people to remain blissfully ignorant about money, transparent public control of the monetary system will require more widespread public knowledge about money as well as more active participation in political life.  Without this vigorous participation and oversight, a specialized financial industry will once again shape the monetary system largely for their own benefit.