Page 1 of 2 MONETARISM ENTERS BANKRUPTCY: Part
2 The burden of elitism
Henry C K Liu This report is the second in a series. Part 1:Monetarism
From its founding in 1913, the dominant guiding principle of US central banking
had been monetary rather than economic, notwithstanding that the Federal
Reserve's founding charter directed it to conduct monetary policy to
"accommodate the needs of commerce and industry".
There is an extensive field of monetarism economics that attempts to define the
causal relationship of economic growth to monetary conditions and policies, but
this body of work has yielded mostly selective positivism to support
ideological preferences for the importance of money. A positive analysis is
supposed to yield a description of what is if left alone without intervention.
Yet "what is" in economics is generally the outcome of policy. Central bank
policymakers have since focused on monetary policies designed to prevent
inflation in order to counter investor fears about money defaulting on its role
as a reliable storer of value. Maximizing the role of money as a storer of
value is often accomplished by sacrificing the role of money as a facilitator
of the maximization of economic value.
Ironically, asset appreciation is viewed by monetarists as growth and not
inflation. Inflation is supposed to be caused primarily by wage increases.
While the preservation of the value of money is not an unworthy cause,
neoclassical economic theory has given the Federal Reserve, the central bank of
the US, doctrinaire justification to ignore policies that promote full
employment. Anti-inflation bias has also prevented the central bank from
reversing the falling income of working families, particularly wage earners and
farmers. Central bankers speak of "liquidation of labor" to detach economic
demand for labor from the natural demand of labor in a growing population. As a
result, monetarists subscribe to stabilization of the nominal money supply
rather than total aggregate nominal demand.
Joseph Schumpeter argues that monetary measures do not allow policymakers to
eliminate economic depression, only to delay it under penalty of more severity
in the future. In a market economy, economic depressions are painful but
unavoidably recurring. Countercyclical monetary measures to provide more money
to keep ill-timed investment on a high level in a depression are not creative
destruction but are positive destruction. And such measures will ultimately be
detrimental to the general welfare.
Artificially high asset prices absorb liquidity to stall economic activities
that lead to high unemployment. High unemployment in a depression is merely a
sign that the market economy is performing its prescribed function. It is the
natural socio-economic mechanism for stabilizing production and consumption.
Unemployment needs to be eliminated, but it cannot be eliminated by monetarist
measures designed to hold up asset prices in a depressed market economy.
Countercyclical fiscal measures are indispensable for the elimination of
unemployment in an economic downturn. In a depression, unemployment can only be
eliminated by fiscal-driven demand management, that is, providing
deficit-financed money through increased work with high wages to the working
population so that they have enough money to buy what they produce without
Herbert Hoover wrote in his memoirs about mainstream liquidationist sentiments
after the 1929 crash:
The "leave-it-alone liquidationists" headed by
Secretary of the Treasury [Andrew] Mellon [1921-1932] ... felt that government
must keep its hands off and let the slump liquidate itself. Mr Mellon had only
one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers,
liquidate real estate.'… He held that even panic was not altogether a bad
thing. He said: 'It will purge the rottenness out of the system. High costs of
living and high living will come down. People will work harder, live a more
moral life. Values will be adjusted, and enterprising people will pick up the
wrecks from less competent people.'
Out of Mellon's
equalitarian liquidationist formula, only liquidating labor has become an
essential part of monetary economics. Theories behind monetary economics harbor
an ideological bias toward preserving the health of the financial sector as a
priority for maintaining the health of the real economy. It is a strictly
elitist trickle-down approach. Take good care of the moneyed rich with
government help and the working poor can take care of themselves by market
forces in a market economy. All are expected to swim or sink in a sea of caveat
emptor risk, but bankers can swim with government-issued life jackets
filled with taxpayer money on account of a rather peculiar myth that without
irresponsible bankers, there can be no functioning economy.
The fact is: while banks are indispensable for a working economy, badly-run
banks ignoring sound banking principles are not. What is needed in a depression
is not more central bank money for distressed banks suffering losses on loans
from collapsed assets prices, but government deficit money to sustain full
employment with living wages.
In popular parlance, the Fed is the government-paid doctor of Wall Street
through taking care of the banking system it regulates, with unlimited state
power to create money backed by the full credit of the United States, a nation
founded as a democratic republic in which sovereign wealth is supposed to
belong to the people, not the banks. Yet the Fed is not the doctor of Main
Street where the nation's wealth is created through full employment and living
Instead, under market capitalism, the fate of Main Street is left to the
manipulated workings of market forces shaped by central bank money freely
available to the financial elite beyond the understanding, control and even
awareness of most retail-market participants. Thus market forces are
manipulated to favor those institutions deemed too big to fail, and at the
expense of the general public who are hapless participants in a manipulated
Central bankers are savvy enough to know that while they can create money, they
cannot create wealth. To bind money to wealth, central bankers must fight
inflation as if it were a financial plague. But the first law of growth
economics states that to create wealth through growth, some inflation must be
tolerated. The solution then is to make the working poor pay for the pain of
inflation by giving the rich a bigger share of the monetized wealth created via
inflation, so that the loss of purchasing power from inflation is mostly borne
by the low-wage working poor, and not by the owners of capital, the monetary
value of which is protection from inflation.
Inflation is deemed benign as long as wages rise at a slower pace than asset
prices. The monetarist iron law of wages worked in the industrial age, with the
resultant excess capacity absorbed by conspicuous consumption of the moneyed
class, although it eventually heralded in the age of revolutions. But the iron
law of wages no longer works in the post-industrial age, in which growth can
only come from demand management because overcapacity has grown beyond the
ability of conspicuous consumption of a few to absorb in an economic democracy.
That has been the basic problem of the global economy for the past three
decades. Low wages have landed the world in its current sorry state of
overcapacity masked by unsustainable demand created by a debt bubble that
finally imploded in July 2007. The whole world is now producing goods and
services made by low-wage workers who cannot afford to buy what they make
except by taking on debt on which they eventually will default.
By its role of lender of last resort to an irresponsible, dysfunctional banking
system, the Fed has essentially banished free markets from the financial
sector. Worst yet, the Fed has in the past two decades mutated into a lender of
first resort, by providing high-power central bank money to commercial banks to
create bank money based on fractional reserve to feed a debt bubble the
eventually burst in 2007. Structured finance enabled banks to securitize risky
loans and remove them from their balance sheets by selling them in globalized
credit markets. Non-bank financial institutions in the so-called shadow banking
system could monetize their liabilities through debt securitization and sell
the collateralized debt obligation as risk-compensatory securities to
I warned in 2002,
... assessment of risks is complicated by recent
structural financial developments in the advanced nations' financial systems,
including increasing global market power concentration in large, complex
banking organizations (LCBOs), the growing reliance on over-the-counter (OTC)
derivatives and structural changes in government securities markets. Despite
all the talk of the need for increased transparency, these structural changes
have reduced transparency about the distribution of financial risks in the
global financial system, rendering market discipline and official oversight
Even blue-chip global giants such as GE, JP Morgan/Chase and CitiGroup have
overhanging dark clouds of undisclosed off-balance-sheet risk exposure.
Ironically, banks in emerging markets are penalized with disproportionate risk
premiums when they fail to meet arbitrary BIS Basel Accord capital
requirements, while LCBOs with astronomical risk exposures in derivatives enjoy
exemption from commensurate risk premiums. (The auto giants were not mentioned
because even in 2002, they were no longer considered as blue-chip companies.
See The BIS vs national
banks Asia Times Online, May 14, 2002).
Alan Greenspan, as chairman of the Fed from 1987 to 2006, proclaimed in 2004:
"Instead of trying to contain a putative bubble by drastic actions with largely
unpredictable consequences, we chose, as we noted in our mid-1999 congressional
testimony, to focus on policies to mitigate the fallout when it occurs and,
hopefully, ease the transition to the next expansion."
By "the next expansion", Greenspan meant the next bubble, which manifested
itself in housing. The "mitigating policy" was another massive injection of
liquidity into the US banking system. There is a structural reason that the
housing bubble replaced the high-tech bubble. Houses cannot be imported like
manufactured goods, although much of the content in houses, such as furniture,
hardware, windows, kitchen equipment and bath fixtures, is manufactured
overseas. Construction jobs cannot be outsourced overseas to take advantage of
cross-border wage arbitrage. Instead, some non-skilled jobs are filled by
low-wage illegal immigrants.
Total outstanding home mortgages in 1999 were US$4.45 trillion and by 2004 this
amount grew to $7.56 trillion, and by 2007 to $11.2 trillion, most of which was
absorbed by refinancing of higher home prices at lower interest rates. When
Greenspan took over at the Fed in 1987, total outstanding home mortgages stood
only at $1.82 trillion. On his watch, outstanding home mortgages quadrupled.
Much of this money has been printed by the Fed, exported through the trade
deficit and re-imported as debt. (See
Greenspan, the Wizard of Bubbleland, Asia Times Online, September 14,
When time comes for the Fed to "mitigate the fall out", the Fed is not the
lender of last resort to the average private citizens in whose name it derives
its money creation power. While the Treasury takes money from private citizens
in the form of taxes, only banks can receive sovereign credit support from the
Fed - not surprisingly, since the Fed, while enjoying the state-granted power
to create high-power money, is a private entity owned and run by its member