Carrying the Water The Role of the Left in the Neoliberal Order

I am struck with disbelief with the apparently unlimited extent of their smug arrogance. It is these very men (and yes, they are mostly men!) who are singularly responsible for the mess we are in. Blair and Clinton in particular presided over the massive accumulation of debt, reckless deregulation and disproportionate and unbalanced boom in our economy which brought us to the precipice. That they and their ilk imagine that they should now be ‘sorting things out’ is cause for worry. In another time they might have been thrown in the dungeon.[1]

All power tends to coopt and absolute power coopts absolutely.[2]

All in all you’re just another brick in the wall.[3]

“Neoliberalism” is the term used to refer to the most recent form capitalism has taken in the modern world. It is shorthand for the new order gestating since the 1970s, characterized by “extensive economic liberalization policies such as privatization, fiscal austerity, deregulation, free trade, and reductions in government spending in order to enhance the role of the private sector in the economy,” as the Wikipedia entry has it. Such characteristics are explanation enough as to why neoliberalism has become a veritable swearword among left-leaning thinkers.

An article by George Monbiot published in The Guardian succinctly summarizes the left’s case against this Novus Ordo Seclorum. The title says it all: “Neoliberalism – the ideology at the root of all our problems.” Neoliberalism is responsible for everything from the 2008 credit crisis to the epidemic of loneliness to the collapse of ecosystems. At its heart is the unfettered individual in competition with other such individuals, wherein “neoliberalism sees competition as the defining characteristic of human relations. It redefines citizens as consumers, whose democratic choices are best exercised by buying and selling, a process that rewards merit and punishes inefficiency… Attempts to limit competition are treated as inimical to liberty.”

Although it rose to ascendancy in the 1970s, as an agenda neoliberalism was first put on the map back in 1938 by the throwback Austrian economists Ludwig von Mises and Friedrich Hayek, in the face of a Keynesian onslaught that carried all before it. They and like-minded thinkers, holding fast to the old-school ideal of limited government and free markets, kept to their belief even when it seemed a lost cause. But their perseverance was repaid. With the collapse of the Keynesian consensus in the 1970s, their ideas gained a new lease on life, and with the ascent to power of Ronald Reagan in the US and Margaret Thatcher in the UK, they became the new political-economic orthodoxy.

Then came the harvest. As Monbiot relates: “massive tax cuts for the rich, the crushing of trade unions, deregulation, privatisation, outsourcing and competition in public services.” And not only in these countries but across the globe: “Through the IMF, the World Bank, the Maastricht treaty and the World Trade Organisation, neoliberal policies were imposed – often without democratic consent – on much of the world.”

The “freedom” neoliberalism promises resembles the “equality” pilloried by Anatole France in The Red Lily (“In its majestic equality, the law forbids rich and poor alike to sleep under bridges, beg in the streets and steal loaves of bread”). For what does it entail? In Mobiot’s words, “freedom from trade unions and collective bargaining means the freedom to suppress wages. Freedom from regulation means the freedom to poison rivers, endanger workers, charge iniquitous rates of interest and design exotic financial instruments. Freedom from tax means freedom from the distribution of wealth that lifts people out of poverty.”

And where such freedom is restricted in rich countries, it is transferred to poor ones, “through trade treaties incorporating ‘investor-state dispute settlement’: offshore tribunals in which corporations can press for the removal of social and environmental protections.”

Essentially, neoliberalism has gutted the state, privatized its services to the detriment of all but the owners, reduced through austerity the transfer payments that “lifts people out of poverty,” and legitimized the destruction of the environment.

Martinez and Garcia provide an additional summary of the neoliberal agenda: 1) the rule of the market, 2) cutting public expenditure for social services, 3) deregulation, 4) privatization, and 5) eliminating the concept of the “public good” or “community.” Here deregulation is added to the list of failures, while the eradication of the pursuit of the public good and community parallel Monbiot’s mention of the epidemic of loneliness.

The roster of witnesses could be multiplied, but without adding much. It is a rather bleak and somber picture that the critics of neoliberalism paint. But things are perhaps even worse than they think they are. For in their critique, they advance hardly any new notions beyond the traditional critiques of capitalism that have been leveled since the emergence of the “social question” in the 19th century. It is rather too easy simply to put the blame for the failures and dysfunctionalities of the modern world system at the feet of traditional free-market capitalism. This enemy has been long defeated; things have progressed far beyond such simplicities. Might there be a reason that precisely this obsolete bogeyman is so energetically pressed as the root of all evil? Might it be that such a critique obscures what is really going on, and hides from us the true problem?

For there are realities to the new “neoliberal” order that this critique does not take into account. This is a form of intellectual blindness. And it is being exploited precisely in favor of neoliberalism.

Is neoliberalism simply old-fashioned classical liberalism (i.e., modern conservatism)? To argue as much is to lose sight of some extremely important factoids. One such, as was documented here, is that budget deficits and spending on social programs are not down, but up. Especially in the wake of the credit crisis of 2008, governments in both the United States and Europe have increased deficit spending, not decreased it. Another is that the developed countries still exhibit high, some would consider crippling, levels of regulation. Spending is therefore not going down, and the regulatory state so decried by conservatives shows no sign of being dismantled.

The critique of neoliberalism proffered by Monbiot et al. is quite simply outmoded. It is based on an exclusive focus on the nation-state as the locus of economic and political activity, supplemented by a likewise outdated center-periphery construct of the relations between nations, whereby e.g. the rich Northern nations exploit the poor Southern nations. But that explanatory framework only obscures the true dynamics of the globalist economic system.[4]

We have explored this system in some detail in previous posts (go here for a catalogue of articles). The important thing to glean from those treatments is that the center-periphery framework of exploitation has been superseded by a transnational corporate arrangement that stands over and outside of specific national constrictions and allegiances.

Sklair provides a succinct summary of this arrangement. “[It] is based on the concept of transnational practices, practices that cross state boundaries but do not necessarily originate with state agencies or actors. Analytically, they operate in three spheres: the economic, the political and the cultural-ideological. The whole is what I mean by ‘the global system’…. The building blocks of the theory are the transnational corporation [TNC], [which is] the characteristic institutional form of economic transnational practices, a still-evolving transnational capitalist class (TCC) in the political sphere, and the culture-ideology of consumerism in the culture-ideology sphere.”[5]

At the heart of this system is, then, the TCC, the transnational capitalist class. This group is the major extractor of surplus value in the modern world. In previous posts we have explored the skewed relationships of nations in the current economic framework, characterized by trade deficits run by some countries and trade surpluses by others. We have noted that this arrangement has to be financed by continuous indebtedness, for every trade imbalance has to be financed, and we have asked the question, why allow these imbalances to continue? Who benefits from this deficit consumerism whereby debt piles up with no end in sight? As I put it here:

Qui bono? Not the workers, neither in the exporting nor in the consuming countries. Rather, it is our familiar friend, [Fernand] Braudel’s “shadowy zone” of behind-the-scenes capitalist power brokers, which benefits from its “commanding position at the pinnacle of the trading community” to steer the profits in its direction and the losses to both ends of the trading network. In this arrangement, there is no core and no periphery – there are only regions of exploitation. The difference is in the form the exploitation takes.

Already in 1977 Goldfrank noted the incipient formation of this new group that would become the TCC:

There is growing evidence that the owners and managers of multinational enterprises are coming to constitute themselves as a powerful social class beyond their role behavior: forming interest groups, engaging in common educational and recreational activity, attempting to include top economic managers in the socialist countries (with which trade and joint investments are increasing rapidly), and working out an ideology in which the world is truly their oyster.[6]

Since then, the literature exploring the TCC has burgeoned. One of the leading proponents of this explanatory framework is Leslie Sklair, now professor emeritus of sociology at the London School of Economics. In the article cited (note 5 above), one of the many he has dedicated to the subject, he provides a succinct outline of the characteristics of the TCC (pp. 521ff.):

  1. Outward-oriented, global perspective. “The growing TNC and World Bank emphasis on ‘free trade’ and the shift from import-substitution to export-promotion strategies of most developing countries over the last decade or two have been driven by members of the TCC.” This is accompanied by a globalist orientation in the training of business managers: “There is now a huge literature in the popular and academic business press on the ‘making of the global manager’ and the ‘globalization of business and management’ … confirming that this is a real phenomenon and not simply the creation of a few ‘globaloney’ myth makers.”
  2. Cosmopolitan “citizens of the world.”
  3. Shared lifestyle, including education and consumption patterns (“luxury goods and services”). Members of the TCC enjoy “exclusive clubs and restaurants, ultra-expensive resorts in all continents, ‘the right places to see and be seen’, private as opposed to mass forms of travel and entertainment and, ominously, increasing residential segregation of the very rich secured by armed guards and electronic surveillance, from Los Angeles to Moscow and from Manila to Beijing.”

As a class the TCC is held together by these elements, oriented about a common goal: the exploitation of the possibilities provided by global consumption. “The culture-ideology of global capitalist consumerism is the fundamental value system that keeps the system intact” (p. 523). And so it behooves this global elite to maintain and foster this state of affairs. Sklair refers to this as the siege mentality of capitalism: “The siege mentality entails the view that social systems are always potentially vulnerable to attack, no less from inside than from outside. Approval, and reward for behaviour which sustains it, must be maintained to ensure the persistence of the system” (p. 517).

This is the imperative: the TCC needs to foster the ideology of global capitalist consumption in order to maintain its hegemony. Thus far, it has been quite successful doing so. “The practical ‘politics’ of this hegemony is the everyday life of consumer society and the promise that it is a global reality for most of the world’s peoples. This is certainly the most persistent image projected by television and the mass media in general. In one sense, therefore, shopping is the most successful social movement, product advertising in its many forms the most successful message, consumerism the most successful ideology of all time” (p. 531).

The success of the TCC in propagating this universal ideology meets us at every turn. The question then is, how in blazes have they done it? It is at this point that our argument takes a curious turn. For we have to proceed beyond the usual consumption critiques revolving around the deleterious effects of advertising (manipulation, subliminal messaging), wastefulness (the throwaway society), and the like. There is an added dimension to this newfangled globalist consumerism, the understanding of which unravels many a mystery.

This added dimension was first referenced (to the author’s knowledge) by David Rieff in a celebrated article published in the August 1993 issue of Harper’s Magazine. Entitled “Multiculturalism’s Silent Partner,” it laid bare a hitherto (and still) unrecognized, because improbable, correlation: the “newly globalized consumer economy” has its flip side in multiculturalism.

Rieff begins his analysis with a tantalizing assertion. In the face of universal agreement that Marxism had died with the Soviet Union, he argues that precisely a Marxist hermeneutic explains the current climate of opinion and practice, which by that time was being dominated by the notion of multiculturalism. “For an application if not of the methods of ‘vulgar’ Marxism then at least of those (related) modes of understanding that are to be found on the business pages of the better newspapers might produce a rather more grounded sense of what we are talking about when we talk and talk about multiculturalism. Despite the denials and mystifications of the intelligentsia, multiculturalism is a phenomenon with a silent partner: the broad and radical change now taking place within world capitalism” (p. 62).

The debate about multiculturalism had given the sense that ideas mattered, that what the intelligentsia of either the right or the left, for or against, had to say on the matter would prove decisive to the social order. Rieff pours cold water on the notion. It is not ideas that are driving this debate, he says; rather, it is the new reality of an emergent global capitalist order.

“Reality is elsewhere,” says Rieff.

Can conservatives really believe that a few curriculum changes will undermine a system that could not be weakened by the Comintern or the Soviet Black Sea fleet? As for our campus revolutionaries: How can they insist on the emancipatory power of multiculturalism when during the 1980s – the very decade in which multiculturalism became the dominant intellectual current in elite sectors of academia – the conditions of the poor, of working-class women, and of America’s non-white citizens deteriorated dramatically? If multiculturalism is what its proponents claim it is, why has its moment seen the richest 1 percent of Americans grow richer and the deunionization of the American workplace? There is something wrong with this picture (p. 63).

There is a new game in town, he writes, and multiculturalism is simply an epiphenomenon thereof. “The curiousness of the situation is that both sides have misconstrued the power of multiculturalism in precisely the same way: as a threat to the capitalist system. In reality, it is nothing of the sort, as becomes clear the moment one stops looking at multiculturalism in ideologized, millenarian terms – as if it were some kind of pure, homegrown manifestation of the Zeitgeist – and instead sees it as perhaps the most salient cultural epiphenomenon of an increasingly globalized capitalist system” (p. 63).

To perceive this is to hold in one’s hand the key to understanding some otherwise puzzling phenomena. For instance, the increasingly incongruous nature of university curricula. “Behind the embrace of multiculturalism among college administrators is the belief that there is no incongruity in simultaneously subsidizing an English department made up of feminists and poststructuralists, a physics department that is up to its eye balls in research grants from the federal government, and an enormous (and enormously profitable) quasi-professional sports establishment, complete with athletes who are students only in the technical sense.” The point is, the mentality has changed: “Once administrators have decided that the university will be a kind of department store, then each new course offering becomes little more than another product line, and department chairpersons begin to act like the store’s buyers” (p. 63).

Far from undermining the detested capitalist system, the presuppositions of multiculturalism turn out to dovetail nicely with those of the new corporate mentality. “The multiculturalist mode is what any smart businessman would prefer. For if all art is deemed as good as all other art, and, for that matter, if the point of art is not greatness but the production of works of art that reflect the culture and aspirations of various ethnic, sexual, or racial subgroups within a society, then one is in a position to increase supply almost at will in order to meet increases in demand” (p. 64). Indeed, culture becomes something of a bazaar; and is that not what makes for good business as well?

Instead of being a rare and costly thing, culture becomes simultaneously a product, like a car – something that can be made new every few years – and an abundant resource, like, well, people. The result is that the consumption of culture can increasingly come to resemble the consumption of goods. After all, just as one cannot say that a preference for Pepsi is superior to a preference for Dr Pepper, what is euphemistically known as “cultural pluralism” permits a similar abdication of judgment in matters of artistic taste. The rules of the market are soon in full control. If students want to read Alice Walker in a literature class instead of the Iliad, fine. The publishing industry certainly has no qualms. It knows it can market Walker more savvily than it can market the Greeks. At any rate, it is not a case, as conservatives allege, of the student as barbarian. Rather, it is a case of the student as customer. And in our society – and, increasingly, most societies – the customer is always right (pp. 64-66).

It is not only students and department heads that are affected by this; professors are as well. The radicals turn out to have found a comfort zone in the new material order, even if that clashes with their professed beliefs.

For all their writings on power, hegemony, and oppression, the campus multiculturalists seem indifferent to the question of where they fit into the material scheme of things. Perhaps it’s tenure, with its way of shielding the senior staff from the rigors of someone else’s bottom-line thinking. Working for an institution in which neither pay nor promotion is connected to performance, job security is guaranteed (after tenure is attained), and pension arrangements are probably the finest in any industry in the country – no wonder a poststructuralist can easily believe that words are deeds. She or he can afford to (p. 66).

Indeed, words offer another telltale sign of confluence. Rieff cites an article by “new historicist” professor Janet Nedelsky in which she writes of the need to do away with boundaries because boundaries indicate, in her words, “a separation and opposition that does not capture the complex, fertile, and tension-laden interconnection between self and others.” But isn’t it curious that this viewpoint regarding boundaries coincides with e.g. Larry Hirschhorn and Thomas Gilmore writing in the Harvard Business Review about the new ideal: the “corporation without boundaries.” Why is the one radical and the other not? In fact, they are equally so.

The more one reads in academic multiculturalist journals and in business publications, and the more one contrasts the speeches of CEOs and the speeches of noted multiculturalist academics, the more one is struck by the similarities in the way they view the world. Far from standing in implacable intellectual opposition to each other, both groups see the same racial and gender transformations in the demographic makeup of the United States and of the American work force…. [B]oth CEOs and Ph.D.’s insist more and more that it is no longer possible to speak in terms of the United States as some fixed, sovereign entity. The world has moved on; capital and labor are mobile; and with each passing year national borders, not to speak of national identities, become less relevant either to consciousness or to commerce (pp. 67-68).

Rieff goes so far as to say that it is business, not the radicals, that is having the more practical effect implementing a multicultural agenda. “The multiculturalists may pride themselves on posing a fundamental threat to what Professor Henry Giroux has called ‘the hegemonic notion that Eurocentric culture is superior to other cultures and traditions by virtue of its canonical status as a universal measure of Western civilization.’ But the reality is that no serious player in the business world has anything but the most vestigial or sentimental interest in Western civilization, as it is roughly understood by campus radicals and conservatives alike.” When everything is submitted to the market for valuation, then all values become relative. The business community has embraced this relativity. “The market economy, now global in scale, is by its nature corrosive of all established hierarchies and certainties…. If any group has embraced the rallying cry ‘Hey, hey, ho, ho, Western culture’s got to go,’ it is the world business elite” (p. 69).

The result may not be what the idealists had in mind. The brave new world of global consumerism is a far cry from visions of egalitarian, environmentally friendly utopia. “The collapse of borders, far from being the liberating event that the academic multiculturalists have envisaged, has brought about the multiculturalism of the market, not the multiculturalism of justice. And if there is a mystery about all this, it is that so many people could have expected a different, more ‘enlightened’ outcome” (p. 70). Nevertheless, it is the reality of the borderless world in which we have landed.

What is revealing is how academics, the proponents of a supposed anti-capitalist alternative, have fallen so easily into line with this “multiculturalism of the market,” ruled as it is by the corporate business world.

Campus radicalism is awfully selective anyway. Its talk is long on race and gender, short on class. And that is probably just as well, since the market economy, ready though it may be to admit blacks and women, is hardly likely to sign its own death warrant by accepting a radical revision of class relations. Were such proposals to be seriously advanced, on campus or elsewhere, the multiculturalists would soon discover just how tough capitalism can be when its real, as opposed to its sentimental, interests are threatened (p. 71).

Indeed, it is in their economic interest to do so. “That is the beauty of the academic multiculturalists’ approach: they can appear to be radical and can feel themselves to be radical, but they can advance a program that, stripped of its adorning rhetoric, is little more than a demand for inclusion, for a piece of the capitalist pie” (p. 71).

This is more than just coincidence. There is more than just a correlation between multiculturalism and globalist corporate capitalism, between the corporate elite and the academic elite. There is in fact the “Marxist” connection to which Rieff refers in his article: the illusion clung to by the left and its intelligentsia that it calls the shots in this culture war, when in reality it is only carrying the water for the global corporate regime.

Rieff makes this clear with a pertinent comparison.

The rise of multicultural capitalism is comparable to abolitionism: the slaves were freed when the abolitionists could count on the support of economic interests in the North, for which an economy based on slavery was an impediment to the future economic well-being of the United States. It was industrial civilization, not justice, that the hardheaded plutocrats of New York and New England were interested in furthering. And until they were convinced that their own interests were at stake, all the oratory of Frederick Douglass, Henry Ward Beecher, and their colleagues was for naught. After they were convinced, this same oratory seemed to sweep all before it (pp. 70-71).

“Seemed to.” It is all so quintessentially Marxian. The economic is the “base,” the intellectual is the “superstructure,” a framework that, “for all their professed respect for the Marxist tradition,” is “out of favor” with the multicultural intellectuals. As well one might expect, given the underlying reality.

This economic base is more than just an abstraction, a Marxian construct. It is the source of funding for the entire academic enterprise, and not only that, for the myriad of activities that impinge upon and determine the direction of the broader culture.

Here we hear echoes of Sklair’s contention that the TCC exerts great effort in gaining and maintaining its hegemony. In fact, we see looming before us one of the ways in which it concretely does so. Another article from the 1990s, in another leading journal of opinion, the New Republic,[7] sheds light on this.

In this article, David Samuels charts a peculiar shift in orientation on the part of the leading foundations. Now foundations are the number one vehicle by which the wealthy influence public policy and the direction of “civil society.” Beginning with the Rockefeller Foundation in 1913, they have had great influence on the development of law, politics, education, and culture. But Samuels notes a shift in foundations’ emphasis, away from broad cultural initiatives and towards narrow advocacy. “Where the Ford Foundation of the 1950s and ’60s spent its money on efforts to promote writing and scholarship at major universities and on symphony orchestras and ballet companies in dozens of American cities, Ford today spends its money on arts projects designed to ‘promote tolerance and social understanding’ and ensure ‘access and equity.’… In the past twenty-five years … a startling shift in foundation funding has occurred, away from research and toward the support of advocacy groups.” This narrow focus has been bolstered by an uncritical atmosphere in which foundation leadership, itself wedded to a multiculturalist agenda, no longer pursues a broad agenda of what once was known as the public interest. It has become a narrow world of its own, without critical openness. “Over the past twenty-five years, the men and women who staff America’s major foundations have become a tight-knit world unto themselves…. The preponderance of foundation grants to advocacy groups … suggests that foundations are less devoted to the reasoned pursuit of the public good than to the multiculturalist dogmas propounded by their staff.”

What could be behind such a shift? Is it that foundations, and the corporate interests behind them, have become wedded to this form of idealism? Are they selflessly pursuing the agenda of “inclusion” and “diversity”? Or is this an expression of Rieff’s base-superstructure relation?

Another critic of foundations and their influence, Joan Roelofs, sheds light on the motivation behind the corporate interest’s advocacy of this agenda. Her critique is rather to the point. “Almost all progressive organizations look to corporations and foundations for funding…. These liberal foundations are closely tied to political and economic elites. Their original founders were wealthy capitalists, and their current trustees and senior staff have close ties to the corporate world. Furthermore, their investments are in the usual high earning corporations…. We are not arguing that foundations are ‘all powerful,’ but rather that their power is enormous, and rarely revealed by scholars, journalists, or activists….”[8]

Foundations, as mentioned earlier, are a prime vehicle through which the corporate elite exercises hegemony. They are used to deflect, defuse, and coopt otherwise dangerously subversive or even revolutionary movements. “Foundations are not opposed to social change, but regard it as necessary and do not see it forthcoming from the political process…. The liberal foundations seek to direct change in a way that will not disturb the wealth and power of corporate elites and the hegemony of the United States” (p. 658). They do so in a myriad of ways. “They are gatekeepers for academics in all fields…. Foundations exert even more direct influence by co-opting activists and their organizations…. The radical activism of the 1960s and 1970s was often transformed, by grants and technical assistance from liberal foundations, into fragmented and local organizations subject to elite control” (p. 662).

As it turns out, multiculturalism, identity politics, and the emphasis on diversity and inclusion are rather convenient ways to attain this end. “Dissidence is fragmented through the creation of organizations for blacks, Hispanics, gays, lesbians, the disabled, Native Americans, and even poor people, who are considered just another minority in need of rights. Foundations have created and funded litigation organizations…. In the early 1970s, the Ford Foundation began to fund women’s studies research centers and academic programs; similar efforts resulted in institutions for other disadvantaged groups. Social movement activists are thereby transformed into researchers, managers, and litigators; and movements are fragmented into ‘identity politics.’”[9]

The strategy of splintering potentially disruptive populations into isolated identity-groups with accreditation in the political process serves to shunt these groups toward the relatively harmless activity of demands for “inclusion,” as Rieff put it, “a piece of the capitalist pie.” Because this does not bring the system itself into question – something which used to be the left’s raison-de-être.

Foundation ideology attributed the radical protests to defects in pluralism. The pluralist ideology holds that any interest is free to organize and to obtain benefits from the system, through peaceful processes of compromise. Disadvantaged groups… needed help in obtaining their rights. Grant money would enable them to participate in the interest group process on an equal basis with the more advantaged groups, and then they would no longer waste their energies in futile disruptive actions…. Poverty, militarism, racism, and environmental degradation are not by-products of the economic system or related to each other. They are merely defects to be corrected through the pluralist political process (p. 31).

What we have here is an ongoing, full-court press, which has been pushing the multicultural agenda during precisely the identical time-frame that the globalist corporate system was being established and expanded – which is, since the 1970s, and especially the 1980s. This is more than coincidence. As Brandt points out, “The Ford Foundation began supporting feminist groups and women’s studies programs in the early 1970s. Just ten years earlier they were busy training Indonesian elites (using Berkeley professors as instructors) to take over from Sukarno, which occurred soon after a CIA-sponsored coup in 1965 that led to the slaughter of hundreds of thousands. Did the folks at Ford Foundation have a bleeding change of heart, or are they continuing the same battle on another front? It would appear to be the latter.”[10]

No, it is not a change of heart, but a change of plan. The TCC means business, and it has for a long time. And its strategy is astoundingly effective. “The ruling elite are experts at manipulating their own interests; they know how to divide and conquer, which is why they continue to rule. As inequality becomes increasingly obvious, those who are less equal begin to see society in terms of ‘us’ and ‘them.’ The dominant culture shades this definition by using the mass media to emphasize our differences at every opportunity. Conventional wisdom becomes articulated within narrow parameters, which is another way of saying that the questions offered for public debate are rigged.”[11]

We are being played, not in the interests of “U.S. hegemony,” as Roelofs supposes, but transnational hegemony, TCC hegemony. We are being splintered into antagonistic identity groups, the better to control us. “The objective is to define ‘us’ and ‘them’ in ways that do not threaten the established order. Today everyone can see that there is more Balkanization on campus, and more racism in society, than there was when affirmative action began over twenty years ago. And for twenty years now one can hardly get through the day without being reminded that race is something that matters, from TV sitcoms all the way down to common application forms (it would have been unthinkable to ask about one’s race on an application form in the 1960s). We are not fighting the system anymore, we’re fighting each other.”[12]

But our problem is not so much discrimination, racism, and the like, but lack of opportunity generally, the byproduct of a system that wishes to hide that very fact. We are being pitted against each other in order to obscure this fundamental underlying reality. That lack is the result of a globalized economy structured in such a way as to squeeze genuine economic opportunity even as it proffers the consolation prize of limited redistribution of wealth and opportunity.

“Transnational accumulation” is what it’s all about; for the rest, let them eat cake. For “none of these dire trends are of any concern to the ruling elites who have the power to address them. They are citizens of the world, and no one – now not even the Soviet bloc – stands in their way. They have no need for borders; free trade is what they want and what they will eventually get. Many on Wall Street prefer unrestricted immigration, which would drive down wages and fold up our few remaining unions. For ruling elites, private security provides insulation and ‘social decay’ is just an irrelevant phrase.”[13]

Does that sound like it was written during the election cycle of 2016? It does – but it dates from 1993! This has been going on for quite a while – and we haven’t even been aware of it. And in this context, the notion of La Trahison des Clercs takes on a whole new meaning. “The campus left speaks of equality, and then forgets about justice by ignoring economic and class distinctions. This failure is so fundamental that multiculturalists should no longer be considered ‘leftists.’ As long as they claim this description, some of us – those who still feel that elites ought to be accountable – are beginning to feel more comfortable as ‘populists.’”[14]

Speaking of the election cycle, it did at last seem as if the left had regained some of its lost resolve, its sense of mission. The candidacy of Bernie Sanders provided a rallying point about which the critics of the system could gather. And there was no shortage of criticism of the leading candidate for the Democratic Party, Hillary Clinton, precisely in terms of a critique of neoliberalism. For Clinton was viewed as the candidate of the ruling class.

In their article entitled “Hillary Clinton’s Empowerment”[15] (subtitled “Hillary Clinton isn’t a champion of women’s rights. She’s the embodiment of corporate feminism”), Kevin Young & Diana C. Sierra Becerra explore the Clinton candidacy in the light of Clinton’s close ties to the corporate business world.

As first lady, Clinton had a significant impact on policy. “Clinton became perhaps the most active first lady in history. While it would be unfair to hold her responsible for all of her husband’s policies, she did play a significant role in shaping and justifying many of them. In Living History she boasts of her role in gutting US welfare: ‘By the time Bill and I left the White House, welfare rolls had dropped 60 percent’ — and not because poverty had dropped. Women and children, the main recipients of welfare, have been the primary victims.” President Clinton’s crime bill was similarly eye-popping from a progressive perspective. “Clinton also lobbied Congress to pass her husband’s deeply racist crime bill, which, Michelle Alexander observes in The New Jim Crow, ‘escalated the drug war beyond what conservatives had imagined possible,’ expanding mass incarceration and the death penalty.”

Of course now Mrs. Clinton is campaigning as if both welfare reform and a tough-on-crime policy were uniquely Republican (racist! sexist!) policy positions. What she does not point out is her own role in putting them in place.

But the real criticism focuses on her years as senator from New York (2001-2009) and secretary of state (2009-2013), during which “her promotion of US corporate profit-making and her aggressive assertion of the US government’s right to intervene in foreign countries” were the two defining features. Young and Becerra quote Bloomberg Businessweek’s assertion that “Clinton turned the State Department into a machine for promoting U.S. business,” seeking “to install herself as the government’s highest-ranking business lobbyist.” They cite her article in Foreign Policy in 2011 which “speaks at length about the objective of ‘opening new markets for American businesses,’ containing no fewer than ten uses of the phrases ‘open markets,’ ‘open trade,’ and permutations thereof.” In that article Clinton champions the Trans-Pacific Partnership (TPP): “Like Bill Clinton’s North American Free Trade Agreement, the deal is intended to further empower multinational corporations at the expense of workers, consumers, and the environment in all countries involved. Lower wages and increased rates of displacement, detention, and physical violence for female and LGBT populations are among the likely consequences, given the results of existing ‘free trade’ agreements.”

They further detail her penchant for militaristic intervention in foreign countries, and cite “neoconservative” Robert Kagan as to her likely policies should she be elected. “‘I feel comfortable with her on foreign policy,’ Kagan told the New York Times last June. Asked what to expect from a Hillary Clinton presidency, Kagan predicted that ‘if she pursues a policy which we think she will pursue, it’s something that might have been called neocon.’ But, he added, ‘clearly her supporters are not going to call it that; they are going to call it something else.’”

Actually, they call it “experience and exposure,” or as Michelle Obama recently put it, “No one in our lifetime has ever had as much experience and exposure to the presidency, not Barack, not Bill, nobody…. And yes, she happens to be a woman.” (Appeal to gender – check!)

Young and Becerra quote Middle East scholar Stephen Zunes, that while “‘Hillary Clinton has been more outspoken than any previous Secretary of State regarding the rights of women and sexual minorities,’ this position is ‘more rhetoric than reality.’”

Given Clinton’s backing of neo-liberal economic policies and war-making by the United States and its allies, her advocacy of women’s rights overseas . . . may have actually set back indigenous feminist movements in the same way that the Bush administration’s “democracy-promotion” agenda was a serious setback to popular struggles for freedom and democracy. . . .

Hillary Clinton’s call for greater respect for women’s rights in Muslim countries never had much credibility while US-manufactured ordinance is blowing up women in Lebanon, Gaza, Iraq, Afghanistan and Pakistan.

The bottom line is, Clinton is a representative of what we have now come to recognize as the TCC. The Clinton Foundation and its various branch activities has ensconced the Clintons firmly in the world of “philanthrocapitalism” with its hegemonic functionality within the global system. The influence peddling which seems to be at the heart of the Clinton email controversy should be seen in the context of this brokerage functionality, mediating relations between the TCC and government. Similarly, the $21 million earned by giving speeches to various corporate, banking, and Wall Street entities since leaving the State Department, and the $153 million total for speechmaking since 2001, are part and parcel of this linchpin functionality within the global system. As I noted in a previous article, Hillary Clinton is the “poster child” of that system.

And what of her opponent in the current election? Whatever one may say of Donald Trump, no one has said that he represents the corporate elite. Quite the opposite. Of course, reality may be otherwise. Were he to be elected, he might turn out to be cooptable as well.

Be that as it may, one thing has become clear. The culture war may have been won by the left, but it was won because the corporate world got behind it and indeed coopted it. This means that progressives should recognize their role within the global system. For given this understanding, the categories “right” and “left” have lost all meaning.

The tragedy in all of this: it is not a matter of right versus left, but top versus bottom. “The ruling elite that finds diversity useful is an elite operating at a level which transcends right and left…. Nothing shows this better than the fact that this ideological right has always been as concerned as the left over the real source of power, the elite globalists…. It’s not a right-left problem, but rather a top-bottom problem.”[16]

And yet the left is so easily egged on to do the dirty work: vituperate conservatives and champion the poster child of the TCC simply because she, as her husband before her, has mastered the art of shifting the blame for all ills to unpopular political opponents. This seems to be the role the left plays within this neoliberal order.

That is why I used the word “role” in the title of this article. To have a role to play is to be put into a particular position in order to perform a particular, scripted, function. It is allocated by whoever is in control of the situation. In other words, the left plays the role set for it by the powers that be, in this case the TCC. And as can be seen in this election cycle, it does so with alacrity, as if the surface phenomenon of a left-versus-right confrontation were the only reality. When the real reality is that this is only an epiphenomenon. The real reality determining the roles and the dance is that of a transnational capitalist hegemony that is busy turning the world into a surplus value yielding colony. The multiculturalist, diversity-oriented agenda in the end turns out to be just another brick in the wall.


 

  1. Rodney Schwartz, “Philanthrocapitalism and Davos make Me Sick!”, ClearlySo Social Business Blog, 5 February 2009.  
  2. Alasdair MacIntyre, After Virtue: A Study in Moral Theory (Notre Dame, IN: University of Notre Dame Press, 19842), p. 109.
  3. Roger Waters (Pink Floyd), “Another Brick in the Wall,” The Wall, 1979.
  4. For a concise criticism of this construct, see William I. Robinson, “The transnational state and the BRICS: a global capitalism perspective,” Third World Quarterly, Vol. 36 No. 1, 2015, pp. 1-21.
  5. Leslie Sklair, “Social movements for global capitalism: the transnational capitalist class in action,” Review of International Political Economy, Vol. 4 No. 3, 1997, p. 520.
  6. Goldfrank, W., “Who rules the world? Class formation at the international level,” Quarterly Journal of Ideology, Vol. 1 No. 2, 1977, p. 35.
  7. “Philanthropical Correctness: The Failure of American Foundations,” The New Republic (September 18 and 25, 1995), pp. 28-36.
  8. Joan Roelofs, “How Foundations Exercise Power,” American Journal of Economics and Sociology, Vol. 74, No. 4 (September, 2015), pp. 655, 657, 658.
  9. Roelofs, Foundations and Public Policy: The Mask of Pluralism (Albany, NY: State University of New York Press, 2003), p. 25.
  10. Daniel Brandt, “Multiculturalism and the Ruling Elite,” NameBase NewsLine, No. 3, October-December 1993.
  11. Brandt, “Multiculturalism and the Ruling Elite.”
  12. Brandt, “Multiculturalism and the Ruling Elite.”
  13. Brandt, “Multiculturalism and the Ruling Elite.”
  14. Brandt, “Multiculturalism and the Ruling Elite.”
  15. In Jacobin, March 9, 2015. Available here.
  16. Brandt, “Multiculturalism and the Ruling Elite.”

Prospects for the European Economy

We can conduct a similar analysis of the European economy as we did for the US economy.

We will restrict our discussion to the Euro Area, the countries which share a common currency, the euro. The euro creates a unique, separate trading bloc, the internal dynamics of which need to be understood both to assess the performance of the individual member countries, and to assess their place in the world economy.

Within the larger scheme of the globalist production and consumption network, the Euro Area plays a unique role. It functions neither as a supply region nor a demand region. The Euro Area’s role vis-à-vis the rest of the world is that of a demand region for raw materials/energy, and a supply region for manufactured products.[1]

Up until 2012, it ran a roughly even balance of trade with the rest of the world, as can be seen from the following graph. Euro Area Balance of Trade

Hence, in the run-up to the credit crisis of 2008, the Euro Area did not run a sizeable trade deficit, as one might expect given its status as a region full of First World “rich” countries.

But this is not to say that it was not afflicted by similar problems of trade imbalances. The difference is that these imbalances manifested themselves within the currency area. In this sense, the Euro Area acted as mini-world economy, manifesting similar consumer/producer relations. Here as well the divorce between production and consumption reared its head.

If we break down the figures for separate countries, this becomes clear. In the following graph, we see development of the current accounts of eight key Euro Area countries.[2]

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Prior to 2001 and the advent of the euro, the current accounts of these countries ran closely together. France and Italy, for example, usually ran current account surpluses, while Germany ran current account deficits. But all of this changed with the advent of the euro. From that point we see wide discrepancies between the various current accounts. Germany and the Netherlands begin running significant surpluses, while countries like Spain, Italy, and Greece begin running significant deficits.

We can glean from this that the Euro Area itself became divided into supply regions and demand regions. Supply regions run trade surpluses; demand regions run deficits. The major net suppliers were Germany and the Netherlands. The major net demanders were Spain, Greece, and Portugal.

We can also glean from this that consumption was paid for, not by reciprocal production, but by debt. As we have learned by now from previous posts, trade imbalances have to be “financed”: in other words, they are paid for by debt. When trade imbalances are incurred, the countries running trade surpluses are also exporting capital: this is called a capital deficit. What they are doing is exporting demand, by exporting excess savings. To put it bluntly: they are extending the credit to the consuming countries that these countries require to buy their production.

Such an arrangement was made palatable by the euro. The euro was to be the panacea for all economic ills. Participation in the euro was to automatically bring participation in prosperity. And in the early years of the euro project, that surely seemed to be the case. Funds flowed freely from North to South, fueling a boom across these countries, especially in the period 2005-2007, as the following graph indicates.

euro area gdp growth splits

Source: World Economic Outlook Database, April 2016

But this growth was fueled by the debt implicit in the current account imbalances shown in the previous graph. Capital exports (i.e., credit from the exporting to the importing countries) were fueling consumption. The assumption was that the euro constituted surety for this indebtedness. The debtor/consumer countries being locked into the arrangement, they would not be able to devalue their currencies to reduce the value of that debt. And so it was safe to furnish the credit that would pay for the southern countries’ consumption.

Spain was at the epicenter of this debt/consumption nexus. We can get an idea of this by juxtaposing external debt with the balance of trade, as pictured in the following graph. Spain Total External Debt

External debt exploded from €600 billion in 2002 to €1.6 trillion in 2008, while the trade deficit deteriorated from $4 billion/month in 2001 to $10 billion/month in 2008.

This debt binge, as in the US, took the form of a housing bubble. “The only way [Spain] was able to grow for many years prior to the crisis was with a surge in domestic credit that expanded the nontradable goods sector – real estate and consumption, for the most part, with surging real estate itself fueling further borrowing and consumption.”[3]

But it was not only Spain that in this manner paid the piper. Other countries as well participated in this spending binge, as the following graphs indicate:

Portugal Total Gross External Debt Greece Gross External Debt

Greece is of course the poster child for the, in retrospect, exorbitant and entirely irresponsible spending spree that characterized the pre-crash period, and which was gladly financed by the exporting countries of the North. The only problem with this method, as we saw with the world economy, is that it is unsustainable. At some point, the punch bowl is taken away, and whoever is left holding the bag is also left holding a slew of “odious debt.”[4]

In the aftermath of the credit crisis, the Euro Area has had to adjust to the collapse in consumer demand, just as has the United States. In one respect the two have followed similar paths: government deficit spending has served to fill the gap. The following graph shows how government debt has grown in the US and in the Euro Area. Euro Area Government Debt to GDP

The trajectories are quite similar, although the magnitudes differ somewhat: the US’s ratio of debt to GDP has burgeoned to over 100%, while that of the Euro Area now exceeds 90%.

This is one way the Euro Area has compensated for the drop in demand. Another is by resorting to exchange rate depreciation. This has improved the terms of trade for Euro Area exports and thus helped improve economic growth. Euro Dollar Exchange Rate - EUR/USD

The trend line refers to the exchange rate of the euro vis-à-vis the dollar, and clearly indicates a downward trend, which has the effect of making Euro Area exports more attractive. Because of this, the surplus on the Euro Area balance of trade has steadily widened. The Euro Area is thus attempting to export its way out of its present difficulties. But we now know where such a strategy leads: to dependence upon foreign demand, which itself is funded by capital exports.

We should make mention of one other attempt to boost demand: quantitative easing. Here as well, the Euro Area has followed the lead of the US, force-feeding the central banks’ balance sheets with bonds, which has the effect of flushing the money market with liquidity.

The following graph shows the extent of the operation. Here again, the trend lines are similar although the magnitudes differ somewhat: the Federal Reserve System now has about $4.5 trillion on its balance sheet, while the Euro System has about €3.4 trillion (about $3.8 trillion at current exchange rates). Euro Area Central Bank Balance Sheet

This together with deficit spending was to bolster economic growth. Nevertheless, that growth has remained fairly anemic: Euro Area GDP Annual Growth Rate

The fact of the matter is, neither of these strategies for fomenting growth are sustainable.

Quantitative easing is only a temporary panacea; at some point those bonds are either returned to the market or become due. In both cases, this removes liquidity from the money market.

The attempt to export one’s way to growth is likewise a dead end, as every country that has tried it has eventually discovered, to its cost. This is why Japan is moribund and why China is heading in that direction. Export-led economies need import-led economies to absorb their production; if those import-led economies for whatever reason stop importing and stop demanding, the export-led economies are left high and dry with essentially superfluous production capacity. On top of that, the trade imbalances that are required for this model require the continual buildup of debt, a similarly unsustainable course of action.

This is the reason why economists like Michael Pettis keep urging these export-led economies to rebalance away from dependence on exports towards a more balanced model based first and foremost on domestic demand. This would restore Palley’s “virtuous circle of growth” and the link between production and consumption, having the one pay for the other in the circular flow of the properly functioning economy.

What stands in the way of this? Recall Pettis’s explanation (in this post) of the techniques by which export-led economies generate excess capital with which to fund trade surpluses. They do so by implementing various policies that in effect force their own citizens to “save” rather than spend. Pettis’s list includes:

  • consumption taxes such as VAT, which reduce by the amount of the tax, the amount consumers may consume;
  • tariffs, which artificially increase the price of imported consumer goods, thus in essence forming another consumption tax;
  • financial repression, in which the state runs the banking system and rigs it in favor of commercial borrowers and against consumers, so that consumers have less money to spend on consumption.

In the European situation, it is VAT which jumps out on this list. VAT constitutes an enormous hindrance to consumption spending. The result is to ease pressure on exchange rates and so foment export performance, but at the expense of domestic consumers.

In his book The Great Rebalancing, Pettis points out another method by which Europe’s economic engine, Germany, has been able to generate the massive trade surpluses it has in recent years, especially in the light of its trade deficits in the 1990s. This came about through wage repression. German workers have agreed to have wage growth restrained in order to promote the greater good, which in this case is the German export machine. Pettis’s explanation merits quotation in extenso:

After German reunification in the early 1990s, Germany faced the problem of very high domestic unemployment. It resolved this by putting into place a number of policies, agreed on by trade unions, businesses, and the government, aimed at constraining wages and consumption and expanding production in order to regain competitiveness and generate jobs. Although these policies may have made sense for Germany and the world in the 1990s, … the creation of the euro introduced a new set of currency and monetary rigidities that would change the impact of these policies both within Germany and abroad.

Specifically, as wage growth was constrained in Germany by relatively tight monetary policy in the German context, it was left unconstrained in peripheral Europe because monetary policy there was, paradoxically, too loose given underlying conditions of rapid growth and rising prices. These policies resulted in an increasingly undervalued euro for Germany relative to the rest of Europe, low wages for its level of productivity, high consumption and income taxes, and expensive infrastructure funded by these taxes.

In that case it is not surprising that German GDP growth exceeded the growth in German household income, because households were effectively forced to subsidize employment growth, and this subsidy reduced disposable household income and consumption relative to total production….

The high German savings rate, in other words, had very little to do with whether Germans were ethnically or culturally programmed to save— contrary to the prevailing cultural stereotype. It was largely the consequence of policies aimed at generating rapid employment growth by restraining German consumption in order to subsidize German manufacturing— usually at the expense of manufacturers elsewhere in Europe and the world.[5]

The upshot of all of this is, Europe is as wedded to the system of neo-mercantilist trade imbalances as is the rest of the world. It is here that change needs to come, but no policy proposals are in the offing that even bring this problem set to the table, much less propose solutions to it.

Notes
  1. “[The] Euro Area runs regular trade surpluses primarily due to its high export of manufactured goods such as machinery and vehicles. [The] Euro area is a net importer of energy and raw materials. Germany, Italy, France and Netherlands account for the largest share of total trade. Main trading partners are the United Kingdom (12 percent of total exports and 10 percent of imports) and the United States (13 percent of exports and 6 percent of imports)” (TradingEconomics.com).
  2. As we outlined in the previous post, the current account is similar to the balance of trade and provides the same sort of indications.
  3. Michael Pettis, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy (Princeton: Princeton University Press, 2014), p. 4/29 of ch. 6 (ebook version).
  4. Jason Manolopoulos, Greece’s ‘Odious’ Debt: The Looting of the Hellenic Republic by the Euro, the Political Elite and the Investment Community (London and New York: Anthem Press, 2011).
  5. The Great Rebalancing, ch. 6, pp. 10-12/19.

Prospects for the US Economy

THE WORLD ECONOMY IN RÉSUMÉ

In the previous post we outlined the structural condition of the world economy, and in particular the structural flaws it contains.

The main flaw is the divorce between production and consumption.

Prior to the establishment of this new macroeconomic structure, supply and demand were roughly in balance in the domestic economy.

We can see this by taking a look at the balance of trade of the United States between 1950 and 1980. In that period, the US economy was the major trading partner for the rest of the world – not to mention that the dollar was then, as it is now, the currency in which world trade is conducted – so that its trade data can serve as a useful proxy for the development of the broader world economy.

United States Balance of Trade

During most of this period, the US balance of trade was roughly in balance. Only towards the end of the period did it begin displaying the sharp divergences that would characterize the period since then, albeit here the magnitude of the imbalances is still very small. As we shall see, they have since taken on major proportions.

During this earlier period, some countries did indeed display trade imbalances. Where this was the case, it was the byproduct of colonialist relationships, such as with “banana republics” the role of which was to produce bananas; the same was true of sugar or rubber or oil. These commodities were produced for export, and the economies depending upon such exports were thus at the mercy of the whims of the world market.[1]

So this lack of balance between supply and demand was an exception to the rule. But since the establishment of the new macroeconomic order, that balance in domestic economies has been rudely disrupted by a new way of linking production and consumption.

In the new structure, the world has been parceled out into various supply and demand regions. Low-wage, developing countries have been designated as supply regions. They are used as sources of raw materials and production. The rich, developed countries have been designated as giant piggy banks. They have been allocated the role of consuming this production.

All of this is orchestrated from the top by the global corporate elite, which uses politicians, the media, the entertainment industry, and academia to further this “bread and circuses” New World Order of universal colonialism. The world is, indeed, their oyster.

This new order no longer balances production and consumption in a symbiotic circular flow within domestic economies. Instead, massive trade imbalances are created, each of which has to be financed. This means that it is debt, not production, that is paying for consumption. The system mortgages the future in favor of the present.

The magnitude of the new order’s collective trade imbalance, and thus dependence on debt, is indicated in the following graph:

The graph shows the current account balance for the world, the advanced economies, and developing economies over the period 1980-2016. The current account balance is a bit different from the balance of trade, as it includes income payments and transfer payments between countries. But these latter are relatively negligible as compared with trade in goods and services. So the two measures are roughly comparable.

What the graph shows is that the changes in the world economy in evidence since the late 1970s accelerated towards the end of the 1990s. Developing countries began generating an enormous collective current account surplus, in line with their role as the world’s producers; while advanced economies developed an enormous current account deficit. This persisted until 2010. With the credit crisis (actually the “debt-funding” crisis) the situation has since reversed somewhat: debt financing has since become hard to come by.

The upshot is that current account (and trade) imbalances became the norm for the world economy during this period, and since these imbalances had to be financed, they have left behind a mountain of debt that at some point will have to be paid off.

Within this framework, the United States has occupied the central role; it is the “consumer of last resort.”

The question now is, has anything changed with regard to the functioning of the US economy to indicate that it has broken with this structurally flawed global economic mechanism? Our conclusion in the previous post was very summary; we opined, with Palley, that stagnation was the direction the economy was headed, given the lack of any sign of a break with this failed model. Let’s look in more detail at the developments in the US economy since the crash.

WHAT THE STIMULUS DID TO PROMOTE ECONOMIC RECOVERY

Prior to the 2008 credit crisis, the US financed its consumption-oriented trade deficit via the housing bubble. This unsustainable method led to the crash. Since then, the US has turned to various schemes, in order to continue to finance this consumption.

The main such policy has been a return to good old-fashioned Keynesian deficit spending. Barack Obama justified this policy back in 2009:

Economists on both the left and the right agree that the last thing a government should do in the middle of a recession is to cut back on spending. You see, when this recession began, many families sat around the kitchen table and tried to figure out where they could cut back. And so have many businesses. And this is a completely reasonable and understandable reaction. But if everybody — if everybody — if every family in America, if every business in America cuts back all at once, then no one is spending any money, which means there are no customers, which means there are more layoffs, which means the economy gets even worse. That’s why the government has to step in and temporarily boost spending in order to stimulate demand.

That speech blames the banks for the crisis, while explaining also why the banks needed to be propped up and bailed out. Only a politician could argue both of these in the same speech and be applauded for it.

The problem with this kind of thinking, as we stressed in the previous post and shall further elaborate below, is that it does nothing to address the underlying structural economic framework that had the crash as its inevitable consequence.

The stimulus came in the form of the American Recovery and Reinvestment Act of 2009. Predictably, the ARRA did not lead to economic recovery. How could it, when it did not even begin to address the underlying problem of debt-financed consumption? The only change was that the government was taking on the debt, rather than consumers directly.

The ARRA set a precedent for deficit spending which has continued, albeit in more muted form, since then. The US has been running record budget deficits in every year since, as can be seen from the following graph:

As can be seen here, the Obama administration has been running deficits that dwarf those even of the George W. Bush administration, which used to take the prize for this dubious distinction.

This has led to a near-doubling of government debt as a percentage of GDP during the Obama administration’s term of office:

United States Government Debt to GDP

All of this deficit spending might be considered beneficial in the long term if it went to funding investment as opposed to consumption – in other words, if it went to addressing the structural flaw of the divorce between production and consumption. Was it being used to finance investment in productive capacity, so as to restore the “virtuous circle?” Borrowing to finance investment is borrowing to finance growth; borrowing to finance consumption, on the other hand, is simply selling the future out to the present.

This is the criterion. So then, what kind of spending has the federal government been engaging in? In the main, it is consumption as opposed to investment spending, as the following pie chart suggests:

Data is for the 2015 federal budget. Source: Politifact.com

Items such as Health (Medicare and Medicaid) and Social Security are not investment but consumption. Other items on the list can be viewed as partly one and partly the other. In particular, social welfare payments and salaries to civil servants/military personnel qualify as consumption.

Therefore, much of this spending is money distributed to citizens to fund consumption. Which means that much of the federal deficit and federal debt goes toward consumption spending. The same holds true for state and local levels of government.

In other words, most of the burgeoning deficit and debt have gone toward picking up the slack left by the bursting of the housing bubble.

This means that Keynesian deficit spending has not been addressing not economic recovery or restoration, but simply maintaining the status quo that gave us the housing bubble in the first place!

Structurally, nothing has changed.

This is evident from an examination of the US trade deficit during the course of the first 16 years of the 21st century, thus both prior to the crash and posterior to it.

The deficit peaked during the artificial boom years prior to the crash. But – and this is the point – since then, although the magnitude of the deficit has decreased, it is still running at nearly $500 billion per annum.

The thing to understand about the trade deficit is that it, too, has to be financed. In other words, the trade deficit has as its flip side, increased debt. How much of that debt ultimately is owed by the federal government, through its deficit spending agenda, is difficult to say. But what we can say it is this: the trade deficit continues unabated, while government deficit spending has grown enormously. The conclusion can be drawn, then, that government spending has picked up at least part of the slack left by the bursting of the housing bubble.

In other words, the structural flaws of the world economy as outlined in the previous post have not been addressed; only different means have been found to keep the system going as it is currently structured, precisely without addressing its structural flaws, because to do so would harm the interests that are profiting from the current arrangement.

WILL FUTURE ECONOMIC POLICY ADDRESS THE STRUCTURAL ISSUE?

The question remains, is there any prospect of this issue being addressed? As we saw in the previous post, Palley had no confidence that it would be with the Obama administration, and his prediction proved to be correct. But what now? With the 2016 elections we are facing a changing of the guard. Can the candidates’ positions shed any light on this?

One thing is for sure, the latest trade deal, known as the Trans-Pacific Partnership (TPP), is on both candidates’ bad list. This despite the fact that President Obama is continuing to push the deal, attempting to get the appropriate legislation passed by Congress before his term of office expires. Clinton’s opposition does appear to have been forced by both Sanders’ and Trump’s vociferous opposition, and many expect a Clinton administration to include among its priorities the passage of this bill, perhaps with minor modifications.

In a nutshell, the problem with this bill is that it sets up further machinery to arrange trade, not in the interests of the particular countries involved, nor to restore the virtuous circle of domestic economies, but to maintain and perpetuate the production/consumption divorce.

What more might we expect from a Clinton administration? Conveniently, we have a major address on economic policy to work with, given by Hillary Clinton on August 11th. Its key proposal is a renewed stimulus plan that ostensibly will provide the greatest investment in “good-paying jobs” since World War II: “We will put Americans to work, building and modernizing our roads, our bridges, our tunnels, our railways, our ports, our airports. We are way overdue for this, my friends. We are living off the investments that were made by our parents’ and grandparents’ generations.”

The problem here, of course, is that this is precisely what Obama promised. ARRA was supposed to provide a major boost to employment, while also renovating the country’s infrastructure. But as the Wall Street Journal put it in a post-mortem (Obama’s Stimulus, Five Years Later),

The federal government poured billions into the government and education sectors, where unemployment was low, but spent only about 10% on promised infrastructure, though the unemployment rate in construction was running in double digits. And some of the individual projects funded by the law were truly appalling. $783,000 was spent on a study of why young people consume malt liquor and marijuana. $92,000 went to the Army Corps of Engineers for costumes for mascots like Bobber the Water Safety Dog. $219,000 funded a study of college “hookups.”

In the main, the money went not to infrastructure, nor even to productive investment generally, but to the maintenance of existing favored activities in “the government and education sectors,” – thus, essentially, as favors to groups largely supportive of Democratic Party politics.

Will it be any different this time around? In terms of dollar amount, Obama’s stimulus dwarfed Hillary’s $275 billion. Donald Trump has also proposed spending on infrastructure. As The Atlantic points out, “Trump, a builder by blood, has pledged to double that figure, at least. He has called for spending up to $1 trillion on new roads, bridges, broadband, and more.”

If that were all that was to it, then we wouldn’t have much to look forward to as far as structural change is concerned. But Trump has made other proposals as well, which are well worth delving into. We defer that analysis to a later date.


 

  1. For an example of the vulnerability of such export-dependent economies, see Jane Jacobs, Cities and the Wealth of Nations (New York: Simon & Schuster, 1984), ch. 4, “Supply Regions,” which uses the example of Uruguay as a country that was totally dependent upon the cattle industry for exports (meat, leather), which got rich from this trade, but which went into steep decline after that trade collapsed in the 1950s.

What This Election is Really All About

The Economics of the 2016 Election Cycle

The current election cycle in the United States is like none other in recent memory. At least in terms of vitriol, it is no contest. But beyond the partisan slams back and forth lies a deeper fundamental reality which really lies at the heart of the contest.

In fact, despite surface appearances, this is not a typical Democrat versus Republican, left-wing versus right-wing, liberal versus conservative, election. It goes far deeper than that.

My own wish is that partisans on both sides would suspend judgement for a moment, follow me through a rather involved analysis of the economics underlying the current political situation, and think through the implications. In advance, the author thanks you for your attention.


Vantage points are everything. We have a good one provided us by the Keynesian economist, Thomas Palley. Palley’s leftist credentials are impeccable, as might be expected from a former Assistant Director of Public Policy for the AFL-CIO. As such, the following exposition can make the claim, at any rate, to being something other than a mere partisan discussion. The hope is that we get beyond the left-right divide as it has manifested itself in the current political landscape, to the underlying realities that transcend that divide as currently manifested.

Back in 2009, Palley wrote a significant article[1] outlining the real underlying causes of the financial meltdown and credit crisis of 2008. In the course of explaining that catastrophic course of events, Palley ends up providing a succinct summation of the condition of the world economy generally, that retains its applicability to this day.

As Palley has it, the standard explanations of market failure do not go nearly far enough, which is a significant admission by a left-leaning economist. For the usual explanation of economic problems provided by economists of this persuasion puts the blame precisely on market failure. This time is different. “Most commentary has … focused on market failure in the housing and credit markets. But what if the house price bubble developed because the economy needed a bubble to ensure continued growth? In that case the real cause of the crisis would be the economy’s underlying macroeconomic structure” (p. 1).

In other words, the housing bubble was not an unfortunate unforeseen occurrence: it was fostered by deliberate, albeit blind, policy. How and why such a situation would actively be pursued, is the burden of Palley’s article.

The roots of the said macroeconomic arrangement actually go back decades. Palley traces them to the onset of the Reagan administration of 1980. “Before 1980, economic policy was designed to achieve full employment, and the economy was characterized by a system in which wages grew with productivity. This configuration created a virtuous circle of growth …. After 1980, with the advent of the new growth model, the commitment to full employment was abandoned as inflationary, with the result that the link between productivity growth and wages was severed. In place of wage growth as the engine of demand growth, the new model substituted borrowing and asset price inflation” (p. 2).

We must register a quibble with the timing of events here. 1980 did not happen in a vacuum. The hyperinflation of the 1970s is what discredited these Keynesian policies and the Reagan policy responses were the fairly obvious policy response. Anyone who lived through that period knows just how helpless everyone felt at the inability to tame the inflation dragon. In that regard, the Reagan response was inevitable and welcomed.

What really precipitated the new macroeconomic arrangement was the abandonment of the previous such arrangement, the post-war Bretton Woods currency and trade setup. This occurred not in 1980, but in 1971, with President Nixon’s abandonment of the dollar-gold link. What this meant was a switch from fixed to floating exchange rates, which together with the advent of OPEC and skyrocketing oil prices, deranged a hitherto relatively stable situation currency and trade situation.

A graph provided in another of Palley’s articles[2] suggests the same correlation:

Productivity and real average hourly wage and compensation of US non-supervisory workers, 1947-2009. Source: EPI analysis of Bureau of Economic Analysis and Bureau of Labor Statistics data.
Productivity and real average hourly wage and compensation of US non-supervisory workers, 1947-2009. Source: EPI analysis of Bureau of Economic Analysis and Bureau of Labor Statistics data.

As can be seen in the accompanying figure, the divergence between productivity and compensation/wages begins in the early 1970s, corresponding with the breakup of Bretton Woods. So, it was the early 1970s and not 1980 that saw the change in fortunes of which we are speaking.

The new arrangement was characterized by a new priority: globalization. The preference for globalization expressed itself in a new attitude toward trade deficits. “Under the earlier economic model, policymakers viewed trade deficits as cause for concern because they represented a leakage of aggregate demand that undermined the virtuous circle of growth. However, under the post-1980 model, trade deficits came to be viewed as semi-virtuous because they helped to control inflation and because they reflected the choices of consumers and business in the marketplace” (p. 5).

This is a crucially important statement. It provides the kernel of what has been happening over the last 40 years. “The virtuous circle of growth” is Palley’s way of formulating what we in our own model (as described in the accompanying course) refer to as the circular flow of the economy. In essence, all economies are local, then regional, then national, and only then international. A “virtuous circle of growth” is what we understand as the domestic economy. But arrangements can be made that discombobulate this order. What we then have is the domestic economy subordinated to supranational interests. In essence, it is a form of colonialism. And that is what Palley is referring to when he speaks of a “leakage of aggregate demand.” The circular flow is disrupted; supply and demand are disconnected from each other in the domestic economy, diverted toward an international economy characterized by trade deficits and surpluses, the ineluctable by-products of these “leakages.”

This arrangement is papered over by appeals to free-market principles. Hence the epithet “neoliberalism.” These trade deficits do indeed help to control inflation, but at a steep price. And they may reflect “the choices of consumers and business in the marketplace,” but without consumers and business realizing that there is a flip side to these cheap imports, and that is the loss of employment and productive capacity.

For what do these trade deficits actually represent? For one thing, the systematic suppression of wages on both sides of the trade equation. “American workers are increasingly competing with lower-paid foreign workers.” This is obvious and well-known. What is less well-known is what is going on with these foreign workers: “That pressure is further increased by the fact that foreign workers are themselves under pressure owing to the so-called Washington Consensus development policy, sponsored by the International Monetary Fund (IMF) and the World Bank, which forces them into the same neoliberal box as American workers.” They are both being disadvantaged; they are being played against each other. For the loss of purchasing power on the part of American workers is not compensated for by increased demand from abroad, for foreign workers likewise are deprived of purchasing power, despite the fact that they are on the receiving end of the job-offshoring program. “Neoliberal policies not only undermine demand in advanced countries, they fail to compensate for this by creating adequate demand in developing countries” (p. 7; emphasis added).

This is the double bind in which workers find themselves, both in developed and developing countries.

In developed countries this arrangement has hit the manufacturing sector particularly hard. The idea has been spread abroad that in the US the decline of the manufacturing sector is the result of inevitable trends, in particular, increased productivity. But this does not explain the loss of jobs: “A smooth long run declining employment share brought about investment and innovation that creates a more efficient manufacturing sector is a fundamentally different proposition from decline caused by adoption of a policy paradigm that dismantles the manufacturing sector by encouraging off-shoring and undermining competitiveness” (p. 4). It is the latter, not the former, that explains the loss of manufacturing jobs. That is to say, the new macroeconomic arrangement with its leakage of production to low-wage countries is the real reason.

Accompanying the loss of manufacturing jobs has been a steady divergence in income share. “Between 1979 and 2006, the income share of the bottom 40 percent of U.S. households decreased significantly, while the income share of the top 20 percent increased dramatically. Moreover, a disproportionate part of that increase went to the 5 percent of families at the very top of income distribution rankings” (p. 6). Palley also points to increased labor market flexibility and the abandonment of full employment as a policy objective as factors behind widening income inequality, but the obvious driver of the process is the pressure on the job market brought on by the offshoring of jobs.

All of this has displaced what Palley terms the “stable virtuous circle growth model based on full employment and wages tied to productivity growth” (p. 9). What has taken its place? The new arrangement “based on rising indebtedness and asset price inflation.” These two, not productive activity, generate the income to fund consumption.

In the new arrangement, production takes place in developing countries, while consumption takes place in developed countries. Production has been divorced from consumption. This is the reality behind the ever-present trade imbalances characterizing the modern global economy.

In the old model, in line with Say’s Law, production funds consumption and consumption, production. This is the circular flow of the domestic economy, Palley’s “virtuous circle growth model.” The new model divorces production from consumption. Production no longer pays for consumption: the producers in developing countries have their wages suppressed, and so cannot provide increased demand, while the consumers in developed countries are not producing and selling enough to pay for their consumption. The shortfall is paid for by taking on debt: in terms of economic jargon, this is known as “financing the trade deficit.”

This in turn leads to asset bubbles. “Since 1980, each U.S. business cycle has seen successively higher debt/income ratios at end of expansions, and the economy has become increasingly dependent on asset price inflation to spur the growth of aggregate demand” (p. 9). Various asset markets have done duty to generate this asset inflation and thus artificial prosperity, yielding the dot.com bubble, stock market bubbles, and housing market bubbles. These bubbles are self-feeding phenomena: increases in asset prices spur borrowing based on those asset prices, which in turn encourages further spending leading to further increases in asset prices. But they also provide income to sustain standards of living that essentially are beyond the means of the underlying wealth-producing capacity of the economy.

Palley speaks in particular of the “the systemic role of house price inflation in driving economic expansions.” He points out that “Over the last 20 years, the economy has tended to expand when house price inflation has exceeded CPI (consumer price index) inflation.” This is true for the Reagan expansion, the Clinton expansion, and the Bush-Cheney expansion, and so is “indicative of the significance of asset price inflation in driving demand under the neo-liberal model” (p. 10), which has truly been a bipartisan affair.

Of course, “The problem with the model is that it is unsustainable.” It requires continued excessive borrowing and continued reductions in savings rates, which can only be sustained by ever-expanding asset inflation, which eventually must come to an end.

This dynamic lay behind the credit crisis of 2008, only this time things were different. Mainly, the degree of indebtedness, the breadth of participation in it – as might be expected from a bubble generated by the broader housing market – far exceeded previous instances and precipitated the enormous blow to the real economy, not to mention the carnage wrought to the financial economy.


Behind this macroeconomic structure lay the disruption of the production-consumption linkage of the domestic economy. It was this that made necessary the generation of artificial prosperity to maintain a standard of living, a level of consumption, without any connection to the level of production.

This macroeconomic structure was supported by trade policy. Palley points to the establishment of the North American Free Trade Agreement (NAFTA), the establishment of the “strong dollar” policy after the East Asian financial crisis of 1997, and permanent normal trade relations (PNTR) with China in 2000, as the “most critical elements” of the global economic arrangement. These were “implemented by the Clinton administration under the guidance of Treasury secretaries [sic] Robert Rubin and Lawrence Summers.” The measures “cemented the model of globalization that had been lobbied for by corporations and their Washington think-tank allies” (pp. 12-13).

The upshot was a global economic arrangement featuring a “triple hemorrhage:” leakage of spending on imports, leakage of jobs overseas, and leakage of investment overseas.

We gained a new economic arrangement in which trade deficits became the rule and the world became the production zone for US corporations, which could turn around and sell this production to compatriot consumers. “At the bidding of corporate interests, the United States joined itself at the hip to the global economy, opening its borders to an inflow of goods and exposing its manufacturing base. This was done without safeguards to address the problems of exchange rate misalignment and systemic trade deficits, or the mercantilist policies of trading partners” (p. 14).

This created a “widening hole” in the economy “undermining domestic production, employment, and investment.”

NAFTA in particular ushered in a new era of exchange-rate policy. “Before, exchange rates mattered for trade and the exchange of goods. Now, they mattered for the location of production” (p. 15). This worked to the advantage, of course, of multinational corporations, enabling them to pursue the policy of producing in low-wage markets and selling the production in developed markets. This in turn led to a strong dollar policy, likewise pushed by multinationals. “This reversed their commercial interest,” as US corporations previously favored a weak dollar, for obvious reasons.

The collapse of the peso in 1994 was a direct result of this new policy. In the new arrangement, the cheap peso was a boon to US corporations producing in Mexico and exporting to the US. “The effects of NAFTA and the peso devaluation were immediately felt in the U.S. manufacturing sector in the form of job loss; diversion of investment; firms using the threat of relocation to repress wages; and an explosion in the goods trade deficit with Mexico …. Whereas prior to the implementation of the NAFTA agreement the United States was running a goods trade surplus with Mexico, immediately afterward the balance turned massively negative and kept growing more negative up to 2007.”

The strong dollar policy was further implemented during the series of financial crises in the late 1990s, starting in East Asia. “In response to these crises, Treasury Secretaries Rubin and Summers adopted the same policy that was used to deal with the 1994 peso crisis, thereby creating a new global system that replicated the pattern of economic integration established with Mexico” (p. 16). The strong dollar increased the purchasing power of the US consumers: “critical because the U.S. consumer was now the lynchpin of the global economy, becoming the buyer of first and last resort.”

One result of this policy was that “manufacturing job growth was negative over the entirety of the Clinton expansion, a first in U.S. business cycle history” (p. 18). Positive business cycle conditions obscured the underlying trends; to add insult to injury, “the Clinton administration dismissed concerns about the long-term dangers of manufacturing job loss. Instead, the official interpretation was that the U.S. economy was experiencing—in the words of senior Clinton economic policy advisers Alan Blinder and Janet Yellen—a ‘fabulous decade’ significantly driven by policy.” Janet Yellen is, of course, the current Chair of the Federal Reserve Board.

The final step in this process was taken when China was granted the status of PNTR and then admitted to the World Trade Organization. “Once again the results were predictable and similar to the pattern established by NAFTA—though the scale was far larger.”

Hence, all the pieces were put in place during the 1980s and 1990s, but they did not come to full fruition until the crisis of 2008. “From that standpoint, the Bush-Cheney administration is not responsible for the financial crisis. Its economic policies … represented a continuation of the policy paradigm already in place. The financial crisis therefore represents the exhaustion of that paradigm rather than being the result of specific policy failures on the part of the Bush-Cheney administration” (p. 21).


Given the above, it is obvious that the credit crisis of 2008 was not the result of the usual suspects, deregulation of financial institutions and banks pushing excessive lending for no other reason but greed. The excessive lending was built into the structure; the entire world economy depended on it, for only through this asset-inflation-induced debt could US consumption, the driving force of economic growth in developing countries, be paid for.

So what is needed is paradigm change. And in this context, Palley, writing in 2009, makes a prophetic statement.

The case for paradigm change has yet to be taken up politically. Those who built the neoliberal system remain in charge of economic policy. Among mainstream economists who have justified the neoliberal system, there has been some change in thinking when it comes to regulation, but there has been no change in thinking regarding the prevailing economic paradigm. This is starkly illustrated in the debate in the United States over globalization, where the evidence of failure is compelling. Yet, any suggestion that the United States should reshape its model of global economic engagement is brushed aside as “protectionism. [sic]”, which avoids the real issue and shuts down debate (p. 25).

“Shuts down debate,” indeed. In the intervening period between 2009 and 2016, the topics of trade deficits, currency arrangements, and multilateral trade deals, have consistently been dismissed as matters of concern, denigrated as unworthy of debate; while proponents of such a re-evaluation have been routinely dismissed as cranks undeserving of serious attention.

As it happens, two candidates for the office of President have put this issue on the table, despite the bile they have received for it: Bernie Sanders and Donald Trump. The concerns of both have been dismissed out of hand by regnant opinion-makers. This should not come as a surprise. After all, “The neoliberal growth model has benefitted the wealthy, while the model of global economic engagement has benefitted large multinational corporations. That gives these powerful political interests, with their money and well-funded captive think tanks, an incentive to block change” (p. 26). Furthermore, “Judging by its top economics personnel, the Obama administration has decided to maintain the system rather than change it,” and subsequent history confirms this. In fact, at the time of writing, President Obama is promoting the latest iteration of this neoliberal arrangement, in the form of the Trans-Pacific Partnership (TPP).

It is not only the Obama administration that continues to push this arrangement. The entire Washington establishment, both Democrat and Republican, is fully behind the continuation of this unsustainable model. Given this intransigence, what is the logical next step? Palley points to it, and subsequent history has only confirmed it: “stagnation is the logical next stage of the existing paradigm” (p. 27). Ever-burgeoning debt that only gets rolled over and never repaid, leads, as the example of Japan teaches, only to economic stagnation, the so-called zombie economy.

Where does Hillary Clinton stand on this issue? Recent statements indicate softening in the direction of Sanders’ position, including announced opposition to TPP. Besides the pronounced skepticism with which such proclamations have been greeted by the left wing of the Democratic Party, there is the little matter of track record. After all, it was during her husband’s administration that all the pieces of the neoliberal program were implemented, and on that, she was with him all the way. Nothing in her subsequent record either as Senator for New York, or as Secretary of State, would indicate otherwise. Quite obviously, her current registered opposition to TPP was driven by Sanders, Trump, and poll numbers.

But beyond this is her place within the framework of what has become the Clinton global network. This network is anchored by a range of institutions: the Clinton Foundation, the Clinton Family Foundation, and the Clinton Global Initiative, among others. The Clinton Foundation was established in 1997 with the purpose to “strengthen the capacity of people throughout the world to meet the challenges of global interdependence.” The Clinton Global Initiative is part of this entity, although between 2009 and 2013 it was hived off, presumably in connection with Clinton’s stint as Secretary of State, to avoid the appearance of conflict.

Articles such as this one from the Washington Post, providing The Inside Story of How the Clintons Built a $2 Billion Global Empire, yield a glimpse into the global reach the Clintons enjoy within the current neoliberal framework. In fact, one might paraphrase Palley’s characterization of the US by saying that indeed the Clintons are joined at the hip with the neoliberal framework. We might go so far as to say that Hillary Clinton is the poster child of this framework, which doubtless is part of reason she enjoys such favorable press despite the fact that she carries so much baggage, of the kind that would have eliminated just about any other candidate.

And so it can be argued that the globalist corporate elite, which props up, and benefits from, the neoliberal arrangement, is promoting the Democrats’ progressive agenda, using it, exploiting it, the better to ensure that this pernicious arrangement remains cemented in place. Hillary Clinton is certainly progressive on social issues. The question is, is she progressive on economics? Let the record speak for itself.

Notes
  1. Thomas I. Palley, “America’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession,” IPE Working Papers 02/2009, Berlin School of Economics and Law, Institute for International Political Economy (IPE). Available at https://goo.gl/gRkfD7.
  2. “Making Finance Serve the Real Economy,” in Thomas I. Palley and Gustav A. Horn (eds.), Restoring Shared Prosperity: A Policy Agenda From Leading Keynesian Economists (CreateSpace Independent Publishing Platform, 2013), p. 74. Available at http://goo.gl/1uJZv6.

Pettis on Brexit

Michael Pettis is one contemporary economist whose blog is worth reading. His books The Volatility Machine and The Great Rebalancing are required reading for those who would understand the workings of international trade relations, currency movements, and financial markets. His comments regarding the recent “Brexit” vote by the UK’s electorate are worth delving into.

“Last Friday’s Brexit turned out to be a far greater shock than most of us had expected,” he writes in his latest newsletter.[1]”I say this fully admitting that I was caught as flat-footed by the vote as anyone else, but not only was I wrong, my own work suggested that this was never as unlikely an outcome as I and most people thought.”

Indeed, anyone familiar with Pettis’s arguments regarding the serious problems facing the European Union should have been expecting such a result, and Pettis points out that followers of his work did just that.

I am glad to say that since the vote an American mutual fund and an Australian hedge fund have told me separately that although they did not expect the outcome, they did not think it was highly unlikely either, and had positioned themselves relatively well. They were both kind enough to tell me that they had done so largely because I had convinced them that the institutional rigidities in the euro zone would continue to undermine the economies of Europe and would cause nationalist and anti-immigrant parties to do extremely well. This would go on until either the European project broke down or the centrist parties radically changed their views.

Pettis goes on to point out that his economic analysis contradicted his own political analysis: “if I had had more confidence in the framework I use and less confidence in my ability to second guess public opinion, I would probably have expected that sooner or later there would be major ‘unexpected’ popular challenge to the European project.”

This happened to him once before, when he was intimately involved in financial constructions in Mexico, and is one reason he no longer seeks close relationships with government officials. In Mexico at the time, he got to know officials responsible for monetary policy intimately well. These officials assured him that Mexico would never devalue the peso, and Pettis, “deeply involved in trading and in arranging and structuring transactions in Latin American fixed income markets especially those of Mexico,” took their word for it. In the event, when Mexico did devalue, these officials were as shocked as he and everyone else. “My blunder was in not seeing the devaluation coming until October, when in retrospect it should have been obvious at least six months earlier.”

The same kind of considerations come into play now with regard to the European Union. In this sense, that economic analysis should not be clouded by official statements or even political wishful thinking. The European Union faces serious structural economic difficulties, and these should not be obscured by hopes regarding the desirability of the project.

To describe the situation Pettis uses the term “credibility Laffer curve.” In order to bolster credibility and assure markets that a country will maintain its exchange rate (e.g., Mexico in 1994) or, in the case of the euro today, that a country (e.g., one of the PIIGS) will stay in the euro, then that country will increase its debt as denominated in the pegged or fixed currency. This will show the world that it intends to stay in that arrangement, come what may. But Pettis argues for a “credibility Laffer curve,” as illustrated in the following graph:

From “Spain, Bankia and the Credibility Problem,” Financial Times, May 30, 2012. Available at http://goo.gl/sAEJqx.

Here, as “monetary severity” increases, credibility increases, but only to a point. After that, credibility begins decreasing again. The increased commitment evidenced in taking on more of this debt will encourage investors to put, or keep, their money in, e.g., Spanish debt; but at some point the amount of debt will reach a point where investors will lose confidence in the credibility of that commitment. And so money will begin ebbing away from that debt market, making the commitment ever less tenable (go here for more on this).

In the current situation, Pettis applies his insight as follows. “I think the ECB is itself now creating a kind of ‘credibility Laffer curve’ similar to that of Mexico, and I suspect I will find several occasions to discuss this concept in the future, but the key point in this particular case is that the great distortions imposed by the euro project, and the wider institutional distortions that have led to high levels of income inequality around the world, have not changed. That is why I should have assumed that any chance for a sharp gapping in public awareness, like the Brexit referendum, might surprise us.”

What is the choice for Europe, in the face of these seismic events in public opinion? “Europe must choose either a major reflation of demand in Germany that redresses the deep imbalances within Europe and reduces the growth of debt in peripheral Europe, although at the expense of more German debt and lower German ‘competitiveness’, or it will be forced to suffer high unemployment and an inexorably rising debt burden in peripheral Europe that will only end after many more years of suffering or with a break-up of the euro. So far it continues with the latter.”

The conclusion? “For this reason we should not be surprised by the continued migration of votes to the nationalist, anti-Europe, anti-immigrant camp. I have been writing about this process for five years and I should not have been shocked to see it happen in England.”

Indeed. Given the astounding reticence to put forward effective policy initiatives (quantitative easing? are you kidding?), these problems will continue to simmer, with responsibility for action continually put off by the current crop of politicians and policymakers, leaving it to the next set of politicians and policymakers to solve, and so on and so on. No amount of emotive appeals to European unity and the European “ideal” will make up for that fecklessness.


 

  1. “Monthly Report, June 29, 2016,” published by Global Source Partners. Pettis’s blog is accessible here.

The Economic Consequences of the Release (i.e., Brexit)

Much has been written on the recent decision by the UK to leave the European Union. Much of it is emotion-driven. But that is no way to assess such an important turn of events. The actual significance is, in significant degree, economic in nature. This calls for an economic analysis, to which we now turn.

The Organisation for Economic Co-operation and Development’s (OECD) Report published in April 2016, entitled The Economic Consequences of Brexit: A Taxing Decision[1], provides a competent summary of the disadvantages that might follow upon a British departure from the EU. We will use it as a reference for interaction.

Initial objections

The initial objections the Report registers are based on circumstantial evidence.

This holds for “Since EU membership in 1973, UK living standards have risen more than in peers” and “A multipolar world implies that the UK is economically stronger as an EU member, and in turn contributes to the EU strength.” (both on p. 9). Despite the graphs, such arguments, are, at best, suggestive rather than demonstrative. The same holds true for the objection that “Uncertainty has already begun to have a negative impact on the economy” (p. 10).

Exchange rates and the balance of trade

The Report then claims that “Uncertainty about Brexit has led to capital outflows and a weaker exchange rate” (p. 12). For a country running a perennial trade deficit, this is anything but objectionable. The graph below shows the development of the UK’s balance of trade since joining the EU (then the European Economic Community) in 1973.UK balance of trade

 

This shows a downward trend, and since the late 1990s, a persistent trade deficit. As such, a decline in the pound’s exchange rate will only help matters, by encouraging exports and discouraging imports.

This leads directly to the next objection, which is a weighty one. “Trade would be hit when the UK formally exits the EU.” If this is the case, it would be dire indeed. Let’s examine the substance.

“The EU remains the main trade partner of the UK and the financial sector benefits from direct access to the Single Market, which has strengthened the comparative advantage of the City” (p. 14). Absolutely true. And by way of elucidation: “Exports to EU countries account for about 12% of UK GDP and about 45% of total UK exports, and for imports the EU is even a more important partner.” This was already implied in the trade deficit data we looked at above.

The graphs below shows the breakdown. The first shows, by percentage, the UK’s export destinations, the second shows the UK’s imports by country of origin (source: The Observatory of Economic Complexity [http://atlas.media.mit.edu]).

UK exports

UK imports

The data is from 2014. As can be seen visually, Europe accounts for the lion’s share of both imports and exports.

The Report includes the following graph on page 15, showing the trade and current account situation between the UK and the EU:

UK current account2

Now then, all of this indicates mutual dependence. Even more than that, though, it indicates that the EU is more dependent upon the UK as a source of income than the other way around, given the fact that the UK runs a trade deficit with the EU. The EU has every reason to maintain existing trade relations with the UK. It would be to the EU’s disadvantage not to do so.

Renegotiating trade deals

The Report goes on to claim that “Negotiating a new trade agreement with the EU is likely to be complex” (p. 16). The various possibilities are laid out in a table, which we reproduce here:

brexit arrangementsThe claim is that negotiations will be complex and that the UK will be on the outside looking in, with the very real possibility of being relegated to “Most Favored Nation” status, in which trade with the EU will be “subject to the EU’s common external tariff.”

For one thing, negotiations need not be complex at all. The website Lawyers for Britain has put together comprehensive, detailed research papers on this issue, of which we gratefully make use. On Brexit and International Trade Treaties, it summarizes the issue both for the UK and for trading partners generally, with the following points (emphasis added to highlight key issues):

  • “Because of the EU customs union and ‘common commercial policy’, the UK is not able to negotiate its own trade agreements with non-member countries — we can only do so as part of the EU. The UK will be able to participate in new trade agreements with non-member countries from the day after exit.  The process of negotiating new trade deals can be started during the 2-year notice period leading up to Brexit, with a view to bringing them into force on or soon after the date of exit.
  • “The EU has existing free trade agreements which currently apply to the UK as an EU member.  Most of these EU agreements are with micro-States or developing countries and only a small number represent significant export markets for the UK.  Both the EU and the member states (including the UK) are parties to these agreements. The UK could simply continue to apply the substantive terms of these agreements on a reciprocal basis after exit unless the counterparty State were actively to object. We can see no rational reason why the counterparty States would object to this course since that would subject their existing export trade into the UK market, which is currently tariff free, to new tariffs. There will be no need for complicated renegotiation of these existing agreements as was misleadingly claimed by pro-Remain propaganda.
  • “The UK was a founder member of EFTA but withdrew when we joined the EEC in 1973.  We could apply to re-join with effect from the day after Brexit. There is no reason why the four current EFTA countries would not welcome us back, given that the UK is one of EFTA’s largest export markets.  EFTA membership would allow us to continue uninterrupted free trade relations with the four EFTA countries, and also to participate in EFTA’s promotion of free trade deals with non-member countries around the world.
  • “The EU is seriously encumbered in trying to negotiate trade agreements by the large number of vociferous protectionist special interests within its borders.  After Brexit, the UK would be able to negotiate new trade deals unencumbered by these special interests much faster than the EU, and with a higher priority for faciliting access to markets for our own export industries including services.
  • “It is completely untrue that you need to be a member of a large bloc like the EU in order to strike trade deals.  The actual record of the EU compared to that (for example) of the EFTA countries demonstrates the direct opposite.
  • “The baseline of our trade relationship with the remaining EU states would be governed by WTO rules which provide for non-discrimination in tariffs, and outlaw discriminatory non-tariff measures. From this baseline, and as the remaining EU’s largest single export market,  we would be in a strong position to negotiate a mutually beneficial deal providing for the continued free flow of goods and services in both directions.  We explain what such a deal would look like in a later post, Brexit – doing a deal with the EU.”

All of this indicates that it will require no herculean effort for the UK to reestablish itself as an independent trading partner, neither vis-à-vis the EU, nor the world at large. After all, the other countries of the world are not members of the EU, and they are surviving. And it bears repeating that for the EU to impose a tariff on UK imports would make no sense at all, because the same kind of tariff would be imposed reciprocally on exports to the UK: all $420 billion of them (from all of Europe, 2014).

All in all, it would be in the EU’s best interest to simply maintain existing trade relations, as they are eminently in its interest.

Other near-term effects

Further near-term effects discussed in the Report, such as a putative “reduction in UK trade openness,” “imposition of tighter controls on inward migration,” leading to “a large negative shock to the UK economy, which would spillover to other European countries” (all p. 21), are either mere surmises or could serve to argue the exact opposite.

The argument that a decline in the exchange rate would have deleterious effects on the UK economy is an example of an argument that could just as well be used to argue the opposite. As discussed above, a decline in the exchange rate would bolster UK exports and inhibit imports, which would benefit the UK and disadvantage the EU. In other words, the neo-mercantilist export policy of the EU countries like German and the Netherlands would be brought more in line with equity.

Long-term effect on trade

The Report goes on to discuss possible long-term effects.

The first one discussed is the trade situation. “The UK is the most attractive destination for FDI in the EU, partly owing to access to the EU internal market” (p. 24). Foreign direct investment would be restricted by withdrawal from this internal market. But again, as noted above, access to the single market is unlikely to be restricted, as the EU derives more advantage from it than the UK. Furthermore, the major inhibitor to direct investment is currency risk. But it’s not like the UK is withdrawing from the euro; it is only rearranging its relation with the EU, with the relation between the pound and the euro (a free float) not changing at all.

Effect of reduced immigration

Secondly, “Immigrants, particularly from EU countries, have boosted GDP growth significantly in the UK” (p. 26). Apparently, immigrants are more productive than native-born Britons. This is obviously a contentious statement; whether it proves anything is another question. Then there is this contention: “Immigrants from the EU make a positive contribution to the public finances, despite relying on the UK welfare system, which is also the case of UK migrants elsewhere in the EU” (p. 27). This is another statement difficult to rhyme with realities. Even if immigrants are all net contributors in terms of social welfare revenues and payouts, the jobs they take, leave other labor market participants without jobs and thus, at least in part, adds to the social welfare rolls (unemployment and other forms of social assistance). In addition, “immigrants from new EU countries have comparatively lower wages…” (p. 27), which means they depress wages, which may be beneficial to employers, but not to employees, and additionally reduce consumption.

The claim is made that reduced immigration would lead to reduced skills, and “A loss of skills would reduce technical progress.” That may be true in the short term, but where there is demand for skills, there will be training and education to enable workers to acquire those skills, and there is no inherent reason why native-born Britons could not be trained up. It is in fact a curious prejudice and form of reverse discrimination to believe otherwise.

The upshot

As a result of these putative disadvantages, the claim is made for a “central scenario” in which “UK GDP is more than 5% below the baseline by 2030.” Just the opposite is at least as likely.

Objections in favor of withdrawal can also be made, of course, but the Report neglects to mention those. One is the fact that the UK is the second-largest net contributor to the EU’s budget, after Germany. Another is that the UK bears a major part of the costs of the EU’s common defense. Yet another is the costs of an inherently cumbersome and inefficient, far-off, relatively unaccountable bureaucracy regulating so much of the economic life of the nation.

But the biggest problem with the EU is tangential to this particular debate. It has to do with the single currency, the euro, in which the UK, of course, is not a participant. The euro forms a massive net drag on the world economy, and the debt overhang to which it has contributed, by having encouraged irresponsible, indeed unconscionable, North-South lending, is an toxic inheritance that not only stifles current economic growth, but also forms a burden that future generations will be hard-pressed to alleviate.

That, however, is stuff for another discussion. For now, it is enough to re-emphasize that, in line with the position outlined here (with an assist here), it is nations, not empires, that create wealth. And that should be kept uppermost in everyone’s mind.


 

  1. Kierzenkowski,R., et al.  (2016), “The Economic Consequences of Brexit: A Taxing Decision”, OECD Economic Policy Papers, No. 16, OECD Publishing, Paris.

The Mystery of Capital in Context

Given the rancorous debate unleashed by the UK electorate’s decision to depart the European Union – in particular, regarding the damage to the UK economy that independence might bring – it seems wise to re-examine the foundations of economic prosperity and its relationship to political and legal factors. I do so by examining Hernando de Soto’s seminal book, The Mystery of Capital, which goes to the heart of the relationship between political framework, legal framework, and economic development.


The “mystery of capital” is the intriguing title of one of the most important books of the new millennium. Written by the Peruvian economist Hernando de Soto, it breaks with the tradition of dealing with capitalism as a system established of, by, and for the rich, by looking at it from the bottom up: from the lowest levels of society. De Soto finds capitalism even at that level, albeit in a stage of dormancy, as it were. His treatise is intended to help us understand that capitalism is nothing esoteric – despite its being a “mystery” – but rather something down to earth, active in the lowest levels of society, and only waiting for a proper legal and political framework to become an equitable system, in the service of all, not just the well-to-do.

De Soto first made a name for himself with his path-breaking work in Peru, which culminated in the best-selling book The Other Path. In order to show an alternative route to a better society, De Soto developed a unique investigative method. At the time – the 1980s – the better society was being promised by radical revolutionary groups. In Peru, such a group was El Sendero Luminoso, the “Shining Path” – the path to the enlightened society, the workers’ paradise. Officially, this was the Communist Party of Peru, and throughout the 1980s it engaged in violent revolution. De Soto proposed El Otro Sendero, the “other path,” which would render the revolution irrelevant by integrating the real-world economies of the poor within an all-embracing economic framework that left no one out.

What De Soto and his colleagues at the Institute for Liberty and Democracy had discovered was that, at the poorest and most basic levels of society, a vibrant economy was already in existence. It functioned in spite of, rather than because of, the formal institutional and legal structures provided by the state. For in Third-World countries such as Peru, there was not one economy but two: the formal economy, the economy of the wealthy and middle class, connected with the rest of the world; and the informal economy, the economy of the poor, the “off the books” economy, comprising the residual and peripheral denizens who happened to make up the vast majority of the nation. Essentially, the legal and political institutions functioned within and for the benefit of the formal economy, while the informal economy ran on its own, ignored and neglected by the powers that be, kept by the phalanx of rules and regulations from ever graduating from the shadows into the sunlight of the economy proper.

De Soto’s book highlighted this situation and the potential that it held, if it could be harnessed, both for the benefit of the poor and for the nation as a whole. Mainly, the regime of bloated regulation and official corruption needed to be exchanged for the rule of law, specifically the institutions of property and contract. If this would occur, the chains would come off of the poor and they could become full-fledged participants in a functional rather than dysfunctional social order.

De Soto’s second book, The Mystery of Capital, is the culmination of the work done in the wake of, and building on the foundations laid in, The Other Path. It is the product of the transfer of the method pioneered in Peru into many other Third World countries facing similar problems. De Soto took his show on the road, making the Institute for Liberty and Democracy into a globally active entity.

Unlike The Other Path, however, The Mystery of Capital is more than an exposition of the findings of investigative field work. In fact, it transcends the empirical method altogether: it sets forth a philosophical outworking that is both result and foundation of those empirical findings.

In making this leap from practice to theory, De Soto had penned a most important book on the subject. He was enabled to do this precisely because of the empirical basis: the book went beyond economic theory to the real world in which economic practice is embedded, a world that economic theory studiously ignores; it takes into account the real-world framework within which economies function.

The recognition of the two-tiered economy led De Soto to perceive the crucial importance of the legal system. For in his findings, it was the legal system that made the difference between the two economies. This led him to explore virtually virgin territory: the relationship between the legal system and the economy has been largely ignored, except for certain specialty (and rather idiosyncratic) disciplines such as institutional economics, “new” institutional economics, and law and economics. While these latter disciplines have not been entirely fruitless, they have not helped to rework economic theory the way that De Soto had done in his book.

De Soto’s reworking of economic theory starts from a rather crucial distinction that is well known to legal philosophers, the distinction between possession and property. This is a staple of the Western legal tradition (both civil and common). Essentially, the difference between possession and property is physical versus mental – possession is physical holding, while property is an entitlement that stays in force regardless of whether the owner is in physical possession or not. And this distinction depends on a functioning legal order that enforces its arrangements. With possession, enforcement is essentially left to the possessor; with property, it is maintained by a separate entity charged with law enforcement, and hence is not dependent upon the physical strength of the owner in order to enforce possession.

With property arrangements, then, the relations of people and things are elevated to a higher plane than arrangements of pure possession. And they provide for higher-order exploitation of resources than simple possession does. For one thing, property rights can be split up and farmed out any number of ways. For another, property allows for encumbrance in credit contracts, whereby the property item serves as collateral. Without changing its physical status, the encumbered asset engenders a new set of economic advantages. The owner can borrow money against it; and, as Steuart showed back in the 18th century and Schumpeter in the 20th, this is essentially the way in which, in the modern world, money comes into being. At least, in a banking- as opposed to a coinage- or scrip-based system. Credit and debt are the source of money issue. As any bank balance sheet will show you, all money issued has as its counterpart an encumbered economic asset.

In his book, De Soto never explicitly refers to the legal doctrine of possession vis-à-vis property, but despite that, it underlies his entire exposition. He argues that it is the legal system that enables possessions to become property, thus assets, and assets to become capital – resources capable of generating new productivity and income. “Like electrical energy, capital will not be generated if the single key facility that produces and fixes it is not in place. Just as a lake needs a hydroelectric plant to produce usable energy, assets need a formal property system to produce significant surplus value. Without formal property to extract their economic potential and convert it into a form that can be easily transported and controlled, the assets of developing and former communist countries are like water in a lake high in the Andes – an untapped stock of potential energy.”[1]

De Soto’s argument is crucially important – as far as it goes. But it runs into problems when he goes further and highlights a single aspect of the legal system, to which he attributes excessive importance. This in turn causes him to lose sight of other aspects, and indeed, the bigger picture.

De Soto emphasizes the role of record-keeping as the determining factor in creating a cognitive layer overlaying the physical layer of tangible things. Records, titles, data storage and retrieval, allow the things that otherwise exist in isolation to be integrated together into a collective mind map, by which they become a synergistic whole that is greater than the sum of the parts. For De Soto, this is the crucial element of a system of property rights, which enables it to generate productive economic assets – capital.

But this is to overplay his hand. It is not so much record-keeping within a framework of law, but the framework of law itself that is the important thing. The key is the establishment of common law: a law that is valid across the board across the entire territory, which holds for everyone and which establishes at its core, property rights and freedom of contract, uniformly and equally enforced. Historically, this kind of common law was established early on in England, where the king’s writ came to run everywhere. Which is why England became the common-law country par excellence.[2]

Such an establishment of common law, in turn, depends upon the consolidation of sovereignty.

Sovereignty is the power by which the rule of law is established. It is the prerequisite of a functioning legal order. Sovereignty is the power to establish and confirm shared, social value. It does this through legislation and adjudication, establishing laws as standards by which the social order is ruled – the rule of law. These, then, are values, which are universally valid and binding.[3]

But there is more to the establishment of value than this. Valuation has, of course, an economic dimension as well as a juridical one. But does the legal system generate economic value? Yes it does, through the utilization of property and contract. And here we have the intangible, mental, symbolic dimension of the economy that De Soto intuits, but does not quite elucidate, given his focus on record-keeping. Property and contract generate value by the process of credit and debt. When property is harnessed as collateral in a credit contract, it is valued; and this valuation is expressed in the issuance of a monetary equivalent. A deposit is established at the bank, in the equivalent of the loan. Borrowing a metaphor from the days of minting coinage, Steuart called this the “melting down” of property into “symbolical” money. Hence, the regime of property and contract participate in the process of valuation in a very critical way. And out of this valuation comes capitalization – capital.

Now then, the context of this valuation and process issuing forth ultimately in that mysterious entity, capital, is a common legal order, the product of a consolidated and viable locus of sovereignty. Sovereignty, then, enables this whole process of capitalization to take place. What is the locus of sovereignty? Following the German Calvinist statesman and political philosopher, Johannes Althusius, we can answer unambiguously, the nation.[4]

The Industrial Revolution, the “take-off,” as W.W. Rostow put it, did not come about in a vacuum. It came about in nations in which sovereignty had been consolidated; and those nations in which sovereignty had not been consolidated, did not experience it. Nationhood and sovereignty go together. Like a lens out of focus, sovereignty is weak where it does not shine through the prism of nationhood. And, where sovereignty is weak, there also a domestic economy does not materialize; as a result, conditions are rife for an exploitative, colonial or neo-colonial framework. Wallerstein’s center-periphery framework then looms large. None of that is necessary for economic growth: in fact, it only benefits particular interests, at the expense of broad-based, populace-elevating economic growth.

So then, it is sovereignty refracted through nation-states that has enabled the genesis of the capital which De Soto seeks to demystify. Summarizing this state of affairs, I wrote: “Through the institutions of property and contract, credit and debt, the asset base in man (human capital) and through man (tangible and intangible property) becomes capitalized, generating a money supply which, when properly maintained, is the faithful representation of that asset base, no more and no less. The nations of the world have no need of a Wizard of Oz to grant them prosperity. It is in their hands to do so, if they would only recognize it.”[5] That is the mystery of capital explained. In its fullness, only nations can bring it off. Neither inchoate peoples, nor empires, ever have, or ever will.


[1] Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000), p. 48.

[2] For more on this point see my book Common Law & Natural Rights (Aalten: WordBridge, 2009), pp. 68ff.

[3] For more on this point see my book Common-Law Conservatism: An Exercise in Paradigm-Shifting (Aalten: WordBridge, 2007), ch. 1.

[4] For more on this point see this previous post.

[5] Follow the Money, p. 190.

Maggie’s Revenge

The British vote on June 23rd, 2016, to leave the European Union, is one of those events that will long be remembered. Yet there was another event involving Britain on the one hand and the European Union (then Community) on the other, that likewise came as a shock, and which likewise lives on in the memory, at least for those who, at the time, were political aware. I refer to Margaret Thatcher’s resignation of the prime ministry, exactly 25 years and seven months earlier, on November 23rd, 1990. Personally, I remember exactly where I was and what I was doing when I heard that bit of news over the radio.

Thatcher’s resignation resulted from her opposition to European union. She paid the price by being cashiered by her own party, not by the electorate. I wrote an article in 1991, discussing this event, its significance, and what I considered to be its historical relevance. In terms of the latter, the article was flawed in its diagnosis, but not in its recognition of that relevance. And today, I think that Margaret Thatcher is looking down with a sense of grim satisfaction.

To honor this event, I excerpt from that article, published in 1991.


It came so suddenly as to leave the world in a state of shock. Margaret Thatcher, the “Iron Lady,” the fighter who would rather die than quit, did just that: she voluntarily resigned her position as Prime Minister of the United Kingdom. She did so as she reflected on what “a funny old world” it should be that a party leader never defeated in a general election, still commanding a majority of her own party, who had led that party to three successive election victories, who had spearheaded a thoroughgoing reformation of public policy whose very name was synonymous with that reformation, should be forced by her own party to resign her post. Truly these were rather funny goings-on.

To top it all, it was not any strictly domestic issue but “European unity” that brought all this about. To many, she was the champion of a by-gone era of national sovereignty and “Little England,” “the prim and condescending leader of a has-been empire bent on turning back the tide of history, a latter day King Canute who actually believed the sea would heed her.”(1) So it was portrayed: Thatcher versus Europe, isolation versus community, proud independence versus peaceful cooperation. And it turned out to be an Achilles’ heel which her opposition lost no time in exploiting as soon as opportunity presented itself.

Her enemies’ strategy worked. But to characterize Margaret Thatcher’s position with respect to the European Community (E.C.) in these terms is, at the very least, open to question. She regarded herself the most pro-European of them all; nevertheless her approach to and her concept of unity differed – fundamentally – from theirs.

Perhaps the key element of difference lay in the goal of monetary union. Thatcher remained to the end staunchly opposed to the formation of a pan-E.C. single currency administered by an independent central bank. Most others see such an arrangement as the indispensable core of a truly common market. Across Europe as a whole, the goal of monetary union commands broad support. Certainly it was this issue more than any other which isolated her from her peer heads of state and made her vulnerable to attack at home.

Such issues have not heretofore been the stuff of dramatic controversy, at least if one follows standard historical accounts. Most historically-conscious folks have a vague recollection, for example, that the establishment of a central bank in the United States was a very hot issue from time to time and was finally brought to pass with the Federal Reserve in 1913 (which isn’t really a true central bank but rather a “federally organized” group of regional banks). But they remain supremely indifferent to the subject and would much rather look into the accounts of politics or war or class struggles, or perhaps “social” histories of “everyday life” in such and such a period. The history of banking and monetary policy is definitely a subject for the specialist. And thus supremely boring.

Yet as contemporary events should insinuate, a long look needs to be taken especially at the history of monetary union. Upon further inquiry that history proves to be decisively important to understanding our present and certainly what Margaret Thatcher would consider our predicament. One has consequently to go back to its roots and see how and why it has become so fundamental – as it truly has – to modern society….

Mrs. Thatcher … faced opposition on two major points – domestically, the poll tax issue, and in external affairs, her position concerning the European Community. The poll tax weakened her position with respect to the electorate, enabling her opposition in the Conservative Party to gain ground on her. But in the final analysis the poll tax is not what felled her.

The timing of events leading to her fall is conclusive here. At the annual party conference in early October [1990], the Conservatives showed themselves lackluster, despondent, without much enthusiasm for the upcoming elections which they feared they might lose. More than anything else, it was the Europe issue that divided them. Many in the party were leaning toward a strong pro-Europe stance; Sir Geoffrey Howe, for instance, argued for full acceptance of monetary union, and Michael Heseltine preached pro-union to a well-attended side meeting. On the other side were the anti-union forces worried that Mrs. Thatcher, who had been showing herself conspicuously indeterminate in the last months, would be “led gently to monetary union, like some doddery old lady, with Mr Major and Mr Douglas Hurd… at either elbow.”(2)

Thatcher herself was then “ambushed” at the E.C. summit in Rome at the end of October. Italy’s prime minister Giulio Andreotti presented a proposal with definite dates for achieving monetary union, something which caught Mrs. Thatcher by surprise. This seems to have woken her from her lethargy. Back home she gave a rousing speech in the House of Commons against monetary union and giving over national sovereignty to Brussels. Her old followers were delighted. Others wondered how long she would last.

It was this speech and her renewed hard line which led to the resignation of Sir Geoffrey Howe from her cabinet. And it was his resignation speech which solidified the opposition against Mrs. Thatcher, prompting Michael Heseltine to run against her in the party election. Howe vociferated against her “anti-Europe” position, arguing that it jeopardized the future of the nation and its role in a united Europe. And then of course Heseltine gained enough votes on the first ballot to force a second one, after which Thatcher resigned.

It was, then, undoubtedly the Europe issue which brought Thatcher’s downfall. That much is clear. In the final analysis, however, not even the politicians were ultimately the cause. The powers-that-be want monetary union, and if anyone stands in their way, they will simply remove him, or her, to get it. The politicians know this and act accordingly if they know what is good for them. The people do not know any better than to accept this goal because it is proffered to them by every available media source from which they derive their opinions.


1. Newsweek, Dec. 3, 1990, p. 22.
2. The Economist, Oct. 31, 1990, p. 43.

The Problem of Saving

When Schumpeter writes, “Now to the question: what is a savings account?”,[1] he is not being facetious. There is more to savings than meets the eye. Of course, the bare fact of saving is simple enough to understand. Rather than spend all of our earnings, we take some and put it to one side. What could be more straightforward?

Actually, the problem is not so much understanding what savings, or a savings account, is, but what kind of effect it has. And that is anything but straightforward.

Essentially, what is accomplished with the act of saving is the removal of circulating medium from the cycle which is what an economy is.

An economy is a cycle or a circular flow: this is one of the first lessons of basic economics, encapsulated in the principle originally put forward by Jean-Baptiste Say, “supply creates its own demand.” All this means is that, at the end of the day, the producers are the consumer and the consumers, the producers. It is the same people producing who do the consuming, and vice versa.

At least, this is the basic picture, before things get complicated with things like foreign trade and fiscal policy. And things like savings. For what savings does is remove some of the circulating medium by which this economic cycle does its cycling. There are two aspects to the cycle: the circulation of goods and service, and the accompanying circulating medium by which the goods and services are accounted. When a shortfall of the circulating medium crops up, the result is deflation. And so, saving on the face of it has a deflating effect on wages and prices. And a deflationary environment is noxious to economic growth.

As a result, we have what economists have dubbed the “paradox of thrift” whereby saving, normally thought of as an act of economic virtue, or at least efficiency, actually depresses economic activity. The details as to how this occurs differ depending on the analyst, but the upshot is that saving, far from being the benign, even constructive act that it may well be on the personal level, actually has, or can have, a negative effect on the economy at large.

So which is it? Do we really have a paradox here along the lines of moral man, immoral society? Is personal saving something good for the individual or the household or other economic entity, but bad for the economy at large?

To figure this out, we have to take a look at what actually happens in the act of saving. First, of course, there is the proverbial mattress, or, especially in the days of coinage, the chest. In such a case, we have the circulating medium definitively removed from the economy for however much time the saver desires. (Or for much longer than that, as witness contemporary discoveries of hoards of coins from e.g. Roman times.) We can call this form of saving “hoarding.” It is peripheral to the main discussion.

What happens in the modern world is something different. When we save, our first resort is not the mattress but the bank. And when we do this, our money earns interest. What is interest? Let’s just say that is another of those phenomena that economists have a hard time figuring out. Perhaps we can address that subject in a future article. For now, we mention it in passing with the caveat that in the contemporary zero-interest-rate environment, it is not the incentive for saving that it normally might be.

So we put our money in banks. What happens then? Does it just sit there, like in the mattress? Not in the modern system. Instead, it enters into a second market, which runs independently of the market for goods and services with which we are already acquainted. We speak of the financial market. Banks (and non-bank financial institutions) are the gatekeepers of this market. We include a graphic taken from the accompanying course to indicate the structure of this second market.

Figure 3:  Two Markets, Two Monetary Circulations
Figure 1:  Two Markets, Two Monetary Circulations

Savings, then, go into this market, where they are “put to use” to earn income for the bank or other financial entity. The differential between what these latter entities earn and the interest they pay out is their profit.

What happens on this market? There are several submarkets which determine this. The bond market is where corporate and government borrowers go to get ahold of some of these savings. The stock market is where corporate interests go to sell stock in their companies – the money that goes here is not savings in the strict sense, as is money lodged with banks, but it does fall under the same category of earnings set aside to earn a separate income and to be available for future use, so we include it in our discussion.

“For future use” – this already indicates that the so-called paradox of thrift need not be so paradoxical. The writers on the problem of saving often seem to talk as if the money put into saving will never come back. In fact, the whole point of saving is to put earnings aside for “a rainy day,” or for the later purchase of big-ticket items, or for retirement – at any rate, not to eliminate it but to return it to circulation at some future time. And in a developed economy, over time the money put aside as savings will be counterbalanced by money previously set aside as savings and now returning to circulation. In addition, this money may have been supplemented by earnings on the financial market, which means that more money will be returning to circulation than left it. So on the face of it, this shouldn’t be a problem.

But there is a problem, and it is this. In normal situations this flow of funds back and forth between the ordinary and the financial markets is not problematic. But in the contemporary situation, it is.

One reason is because the ordinary market is being hit from various directions, making it unproductive and therefore unattractive. Firstly there are what Jane Jacobs (see this post for more on her) called “transactions of decline,” in which government removes money from productive activities, precisely because they are productive, and redistributes it to non-productive activities, precisely because they are unproductive. This can have a Keynesian motivation, whereby Say’s Law is turned on its head: demand then creates its own supply, and all government has to do is distribute money around to consumers (breaking the link between production and consumption) to generate productivity. According to Keynesians, this should in and of itself bring about prosperity, but as Jacobs points out, it only undermines productive activity and the human capital that underlies that productive activity, and so becomes a self-generating downward spiral.

Other things government engages in that undermine productivity are excessive taxation and regulation. All of this makes the ordinary market an unproductive affair, in which risks exceed rewards. The upshot is that savers put their money, not in ordinary investment, but in the financial market, which essentially is a zero-sum game, but in which at least the prospect of a decent return beckons.

And so more funds flow into the financial market than flow out, creating a dearth of liquidity in the ordinary market, which manifests itself in low interest rates combined with difficulty in borrowing (despite those low interest rates).

The flip side of the dearth of liquidity in the ordinary market is a glut of liquidity in the financial market. As funds pile into the market, returns there diminish and the quest for “alpha” (market-beating returns) becomes a frenzy. This is what happened during the 2000s in the run-up to the credit crisis. With the excess liquidity in the financial market, funds were available for lending that never would have been lent in a normal risk/reward analysis, often under political duress. An example is the subprime lending that took place. Michael Lewis (see this post for more on him) wrote about this in two of his most important books, The Big Short and Boomerang (the latter in particular gives a dramatic picture of the workings of the liquidity glut).

This was exacerbated by the trillions of dollars kept in the financial market by exporting countries like Japan and China (see this post this post for more on this), in their attempts to hold down the values of their domestic currencies. That in itself added substantially to the glut. But the very fact that what these countries were doing– looked at globally – was further undermining productivity by destroying productive capacity in rich countries while misdirecting investment in their own countries, only meant that another nail was being driven in the coffin of the ordinary market. Such “global value chains,” when established and maintained through currency manipulation and other fiscal and monetary policies designed to create unfair advantage for exporters at everyone else’s expense, only make the ordinary market even less attractive, which is another reason for the flight to financial markets, and even to inert investments like gold and other luxury items such as works of art.

A lot of work has to be done to restore ordinary markets to decent functionality. One of these is a return to an emphasis on the national economy as opposed to the lopsided emphasis on global-value-chain globalism such as obtains today. And within the national economy, a return to emphasizing the production side of the economy. Consumption does not magically engender productive activity; in particular, deficit spending to fund consumption is as pernicious a fiscal policy as can be devised. Various forms of capital are needed for that, various forms of infrastructure, from legal to educational (virtue versus entitlement) to religious. All of this is fodder for new discussions, so we’ll leave it at that for now.

This topic and more are dealt with more fully in the accompanying course.


[1] Treatise on Money, p. 147.

The Trouble with Exchange Rates

Do floating exchange rates work? By which we mean, do floating exchange rates bring countries, national economies, into equilibrium? Equilibrium here means that trade between countries is in balance. Thus, exports and imports of goods and services, although in constant fluctuation as economies progress along divergent paths, balance each other over time.

With this we do not refer to the total global trade balance. By definition, this will always sum to zero. The problem of imbalances crops up when certain countries run persistent surpluses and/or deficits. Because then, precisely by virtue of the zero-sum condition, other countries will have to run the reverse, a persistent mirror image, whether surplus or deficit. And the question then is, how is this possible in an age of floating exchange rates? In terms of theory, at least, floating exchange rates should compensate for such imbalances. If a country is running a trade surplus, the currency should appreciate, and vice versa if it is running a deficit, and this should result in the trade surplus or deficit being eliminated. But we have countries that run persistent surpluses or deficits. So what is going on?

The current regime of floating exchange rates has been in place ever since President Nixon eliminated the link between the dollar and gold back in 1971. Prior to that, we had the Bretton Woods system, in which the dollar was linked to gold, and was established as the reserve currency for the world’s monetary systems. Since then, the dollar has still officially played the role of the world’s reserve currency, but no longer like it used to. Back in the day, it was the means by which countries could maintain their currencies at the agreed-upon fixed rate: they needed to hold a certain level of reserves to maintain that exchange rate of their currency. Nowadays, of course, not being obligated to maintain a particular exchange rate, the need to maintain dollar reserves falls away. Or so one would think.

The fact is, even in an age of floating exchange rates, the “float” can be undermined and even negated, precisely by making use of dollar reserves. Two questions: how does this work? And, why would a country want to do this?

The first question, as to how it works: by resorting to techniques that were originally developed during the days of the gold standard (in order to short-circuit it) and have since been fine-tuned.

Essentially, since the dollar is the currency in which international trade takes place, a currency’s exchange rate with the dollar can be depressed by keeping dollar earnings from being exchanged into that currency. This is done by “sterilization,” the process of diverting dollar earnings from being converted into the domestic currency and repatriated into the domestic economy. This keeps the domestic economy from being “inflated” – from feeling the effects of prosperity, and, crucially, from importing more, which would force up the exchange rate. Therefore, export prospects remain undiminished, but at the expense of household consumption. The export machine is maintained at the expense of domestic prosperity. This is referred to as “forced savings,” which is really forced underconsumption.

There are other ways to accomplish the same goal. One is to impose a consumption tax. What this does is reduce spending without reducing production. There is then a surplus of production over consumption, and the surplus production is exported. The exchange rate depreciates, not by any active central-bank intervention, but because demand for the domestic currency declines on foreign exchanges – despite the fact that the country is running a trade surplus. Tariffs work in a similar manner. “Tariffs and consumption taxes always … increase net exports by reducing the real value of disposable household income [vis-à-vis importable goods] and so, presumably, by reducing household consumption.”[1]

Another way is through what Michael Pettis refers to as financial repression. Pettis in fact writes that “financial repression matters to trade even more than undervalued currencies.” Financial repression occurs when countries control the banking system and treat it like a department of state. In that case, the central bank sets interest rates that banks are required to follow, and these interest rates are set at a below-market level. Since households and consumers have no other place to put their money, they are required to accept this below-market interest income. This constitutes a subsidy forcibly paid by households to borrowers – companies. Business borrows at below-market prices, while consumers have interest income taken from them. The result is reduced consumption, and the same effect as discussed above with the consumption tax.

The question then is, why would a country want to do this? After all, we have been conditioned to think that an appreciating currency is a strong currency and a strong currency is a desirable thing to have. The fact of the matter is, for an exporting country which has built its prosperity on maintaining a trade surplus, a weak currency is a must.

This strategy is a staple of the Asian Tiger model of economic development. Starting with Japan, the Asian Tiger economies have pursued policies by which trade surpluses could be maintained. The following graphs give an indication of the success these policies have had in helping these countries’ export industries:

South Korea Balance of Trade Taiwan Balance of Trade Japan Balance of Trade China Balance of Trade Singapore Balance of Trade

Similar things can be said about Germany. This country likewise resorts to consumption-repressing policies, although nothing so drastic as the financial repression characteristic of countries like China. And as far as currency manipulation is concerned, Germany is part of the European Monetary Union and so shares a common currency, the euro, with the other member countries, and so cannot engage in currency manipulation. But Germany runs consistent current account surpluses with other member countries of the EMU. How? By virtue of the fact that its exchange rate was locked in at an artificially low level while those other countries were locked in at an artificially high level, and by voluntarily constraining wage growth (via agreement between labor unions, businesses, and government). The result can be seen in this post I wrote a couple of years back.

All in all, pretty much the same thing can be said of floating exchange rates as has been said of humility, Biblical welfare, conservatism, capitalism, even love: it works every time it’s tried. The problem is, it isn’t tried, even in this age of ostensibly floating national currencies. But there are signs that the problem is being recognized, as witness the spate of books dealing with currency wars. Even politicians are getting into the act: Donald Trump pledges to confront China’s currency manipulation. How this will play out going forward is anyone’s guess. But it will most likely continue to remain a bone of contention and true obstacle to realizing a more prosperous and equitable global order.


 

  1. Michael Pettis, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy(Princeton: Princeton University Press, 2014) , p. 30. Pettis is professor of finance and economics at Peking University.