Fed Chairman Ben Bernanke finishes his term of office at the end of this month. He signed off with speech at the annual meeting of the American Economics Association last Friday ( http://www.federalreserve.gov/newsevents/speech/bernanke20140103a.htm). The AEA is the association that best represents all the mainstream economists of America. Speaking to his friends, Bernanke took the opportunity to pronounce on the success of his policies in avoiding a financial meltdown when the global crisis erupted in 2008. He emphasised how the Fed had reacted successfully to turn things round.
For Bernanke, the global financial collapse “bore a strong family resemblance to a classic financial panic, except that it took place in the complex environment of the 21st century global financial system.” He offered a passing reason for the failure of his fellow economists at the AEA (including himself) to see it coming: “our expectations about the possible macroeconomic effects of house price declines were shaped by the apparent analogy to the bursting of the dot-com bubble a few years earlier. That earlier bust also involved a large reduction in paper wealth but was followed by only a mild recession. In the event, of course, the bursting of the housing bubble helped trigger the most severe financial crisis since the Great Depression. It did so because, unlike the earlier decline in equity prices, it interacted with critical vulnerabilities in the financial system and in government regulation that allowed what were initially moderate aggregate losses to subprime mortgage holders to cascade through the financial system. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, deficiencies in risk measurement and management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”
So, for Bernanke, the crisis was purely financial in origin.It had nothing to do with any flaws or contradictions in the capitalist mode of production, but was due to a relaxation on mortgage lending which led to a housing bubble that burst; too much leverage (borrowing) for speculation; and the use of ‘exotic’ financial instruments that did not ‘diversify’ the risks of lending too much, but instead redistributed it globally. This explanation of the widespread and deep nature of the financial panic’ is clearly correct in describing the triggers of the global financial crash. But it does not explain why it happened and why then.
Bernanke, in his academic mode, had established his reputation as the leading economic historian of the Great Depression of the 1930s. In his view, following his hero, Milton Friedman (see my post, https://thenextrecession.wordpress.com/2013/10/06/bernanke-banking-crashes-and-recessions/), the Great Depression was the result of wrong policies adopted by the Federal Reserve. First, the Fed in the 1920s allowed excessive lending and kept interest rates too low. Then in the 1930s it applied too tight a monetary policy and raised interest rates. The result was a stock market bubble and then an extended depression in growth and employment. In this crisis, as he says in his AEA address, he applied monetary policies to avoid similar mistakes. The Fed cut its lending rate to near zero, extended huge financial assistance to the banking system, in particular, the largest investment banks that were ‘too big to fail’, and then applied ‘unconventional’ monetary policies, namely expanding the quantity of money (quantitative easing) by buying up government, corporate and mortgage bonds from the banks to stimulate the economy. The Fed’s balance sheet has rocketed through QE purchases to near $4trn, or 25% of US GDP.
Bernanke is convinced that this policy was a success in saving the capitalist economy. But was it? First, it did not really avoid a financial meltdown. Sure, the likes of Goldman Sachs, Morgan Stanley or JP Morgan did not go bust. But Bears Stearns, AEG and Lehmans did (and Merrill Lynch nearly did). And so did most of the leading mortgage lenders. Moreover, hundreds of smaller banks and lenders across the US went bust. There was a financial meltdown across the globe too that cost taxpayers something like $3trn, at least, in cash and loans to steady the ship.
Second, Bernanke ‘s great anti-depression monetary policies have not restored world and US economic growth and employment back to pre-crisis levels. In his speech, Bernanke claimed that: “Skeptics have pointed out that the pace of recovery has been disappointingly slow, with inflation-adjusted GDP growth averaging only slightly higher than a 2 percent annual rate over the past few years and inflation below the Committee’s 2 percent longer-term target. However, as I will discuss, the recovery has faced powerful headwinds, suggesting that economic growth might well have been considerably weaker, or even negative, without substantial monetary policy support. For the most part, research supports the conclusion that the combination of forward guidance and large-scale asset purchases has helped promote the recovery. For example, changes in guidance appear to shift interest rate expectations, and the preponderance of studies show that asset purchases push down longer-term interest rates and boost asset prices.These changes in financial conditions in turn appear to have provided material support to the economy.”
Really? During the crisis, one Keynesian economist, Robert Farmer reckoned that the Fed should take drastic action and start buying stocks directly to raise stock market prices (something that the Bank of Japan has been doing recently in a limited way) – see my post, https://thenextrecession.wordpress.com/2010/06/02/the-keynesian-answer-support-the-speculators/. Farmer reckoned that these purchases (by printing money) would boost the stock market and thus restore the wealth of investors, enabling them to start buying more consumer goods and invest and thus raise ‘effective demand’ (to use the Keynesian term). Well, Bernanke did not do that but the Fed did the next best thing. It injected so much cash into the financial system that it has led to massive rise in the stock market. Based on the real (inflation-adjusted) S&P Composite monthly averages of daily closes, the S&P is now 119% above the 2009 low, although still 9% below the 2000 high.
But this has not led to a restoration of economic growth, employment and average income, as Farmer claimed and Bernanke hoped it would. US economic growth remains well below trend, unemployment, especially long-term unemployment, remains well above average and average household income in real terms is way down (see Doug Short, http://www.advisorperspectives.com/dshort/).
Bernanke admitted this in his speech: “the recovery clearly remains incomplete. At 7 percent, the unemployment rate still is elevated. The number of long-term unemployed remains unusually high, and other measures of labor underutilization, such as the number of people who are working part time for economic reasons, have improved less than the unemployment rate. Labor force participation has continued to decline, and, although some of this decline reflects longer-term trends that were in place prior to the crisis, some of it likely reflects potential workers’ discouragement about job prospects. “
Bernanke’s policies may have worked for the big investment banks and for stock market and property investors, but it has not worked for Main Street or for the bulk of working people and the unemployed. Main Street corporate America does not appear sufficiently encouraged to start using the huge cash balances they have built up from increased profits engendered by cutting staff and keeping wage rises to the minimum. Profit margins for the large companies are near all-time highs and cash reserves have accumulated, but there is little corresponding investment in the real economy; instead it is in dividends, stock buybacks and speculation in financial assets. And, of course, a revival of the property markets. US home prices are racing up from deep lows at over 13% a year.
I have discussed why corporate investment in the US (and even more so elsewhere) remains in the doldrums despite high cash reserves and profits (at least for the largest companies – not small businesses) – see my post, https://thenextrecession.wordpress.com/2013/12/04/cash-hoarding-profitability-and-debt/. Profitability is still below pre-crisis levels (and below that of the neo-liberal peak of 1997); there are still high levels of corporate debt; and there is uncertainty among corporations about the future, so they are setting a high threshold for what they consider is a profitable investment. Instead, executives are more concerned with keeping the company stock price up and dividends high rather than investing in risky new technology.
Sam Williams in his excellent blog (http://critiqueofcrisistheory.wordpress.com/)
has also recently expounded reasons for this so-called conundrum between profits, the stock market and investment in production (http://critiqueofcrisistheory.wordpress.com/change-of-guard-at-the-fed-the-specter-of-secular-stagnation-and-some-questions-of-monetary-theory/).
Sam puts it: “When a crisis strikes, the capitalists in order to minimize the risk of a loss of all or a part of their capital are forced to attempt to convert all their accounts receivable into cash as quickly as they can. They therefore demand immediate payment on accounts that are only slightly overdue, become very reluctant to sell commodities for anything but cash, and demand payment on all “callable” loans. Similarly, the capitalists are faced with demands for immediate payment of any payables that have fallen even slightly behind their due dates or are in any sense “callable.” The whole chain of credit suddenly contracts.”
Such is the description of the credit crunch and the ‘financial panic’. Sam goes on: “For the capitalists, the means of defense against such a situation is a large cash hoard. With profits low if not negative, the “opportunity cost” of holding cash is not nearly as great as it would be in times of prosperity. And unlike real capital (factory buildings, machines, raw materials and so on), cash can be used to pay off any debts they owe to their fellow capitalists. Therefore, during periods of credit contraction – “de-leveraging” – that begin with the crisis and extend through the post-crisis stagnation, the capitalists do all they can to build up their cash hoards. As a result of this process, the jerry-built structure of credit is replaced with a system based far more on solid cash. The economy reverts to a much “sounder” cash economy but at the price of a more or less extended period of economic stagnation.”
So the longer the necessary period of deleveraging, the longer these cash hoards will be held and accumulated. I’ll let Sam expound further here: “During the period of “de-leveraging,” as the phase of credit contraction is called, new investments in either commodity capital – inventories – or fixed assets is postponed as long as possible. The amount of cash grows, but its velocity as currency slows, so the rise in potential purchasing power represented by the growing quantity of cash is not matched by an expansion of actual demand. This is exactly the situation that we have seen since the last crisis began in 2007-08. The banks and corporations are building up large cash balances that if they were spent – or lent out – would quickly end the current stagnation. Between 2008 and 2012, in the first four year following the crisis, the value of “total assets” of the U.S. economy, according to the Federal Reserve, increased a modest 12.65 percent. The value of non-financial assets – more or less real capital – increased a mere 4.37 percent. In contrast, financial assets increased 23.48 percent. But the real star among financial assets has been checkable deposits – deposits that yield little or no interest but are used as means of payment. These types of deposits increased an astounding 2,700 percent in the four years that followed the crisis. The increase in interest-bearing time deposits that cannot be used as a means of payment increased at a still substantial but far more modest 56 percent. This is the classic symptom of profound stagnation in the process of capitalist expanded reproduction.”
Here Sam echoes renewed talk among mainstream economists that the US economy may be stuck in some form of secular stagnation: permanently low output and employment growth that can only be sustained by continual bouts of credit injections producing permanent bubbles in the stock and property markets. Such is the view of leading Keynesian gurus like Larry Summers, Paul Krugman and Martin Wolf (see my post, https://thenextrecession.wordpress.com/2013/11/30/secular-stagnation-or-permanent-bubbles/). This view has been attacked by right-wing economists like John Taylor who continue to hold to the view that any slowdown in the recovery has been caused interference in ‘free markets’ by the likes of Bernanke with his ‘unconventional” policies like QE or by too much regulation of the financial sector! If the automatic processes of the market were allowed to operate to normalise interest rates and money supply, the capitalist sector would soon stride forward.
Well, both the Keynesian stagnationists and the free market deregulators are right and wrong. There is clearly a slowdown in the long-term trend growth of output in the US economy and it is nothing to do with Fed interference in the economy. But by by propping up the likes of Goldman Sachs and buying up the debts of banks, in way, Fed policy is delaying the necessary ‘cleansing’ of the system of fictitious capital and achievement of higher profitability after ‘deleveraging’ old debt.
The US Congressional Budget Office has estimated the full potential for US real GDP growth since 1950. This excludes the cycles of boom and slump and looks at the long-term growth potential (graph).
It shows that potential GDP growth has been slowing since the Golden Age of the 1960s. Back then, the economy could be expected to grow at around 4%-plus at full capacity; in the last decade it can do no better than 2% maximum on average. Capitalist production growth in the major economies has been slowing down and appears to have entered a depression.
This measure of potential GDP growth is composed of the growth of the labour force; net investment growth i.e. in new plant and equipment after covering for the depreciation of the old; and productivity growth from innovations in technology and organisation (see 13q4_technology). The evidence shows that employment growth has slowed with population growth in the major economies, at least until recently. And net investment growth has been on a secular decline – as a result of the secular decline in the profitability of capital and particularly for new investment since the 1960s (see roberts_michael-a_world_rate_of_profit.). Innovation too appears to be on hold (see my post, https://thenextrecession.wordpress.com/2012/09/12/crisis-or-breakdown/).
The real reasons for the slow recovery from the Great Recession are ignored by Bernanke, the Keynesian stagnationists and neoclassical free marketeers alike. First there is the relatively low profitability of capital and then there is the continued high level of debt incurred by the capitalist sector (banks with their mortgage lending and corporations) that has not been cleared. Here again is the graph of the Bank of England’s estimate for overall debt in the major economies. Since 2007, only the US has achieved any deleveraging of private sector debt and that has been mainly in mortgage debt through defaults.
In their very latest paper on global debt, Carmen Reinhart and Kenneth Rogoff reveal the explosion of private sector debt before the global ‘financial panic’ that Bernanke describes (Reinhart and Rogoff wp13266). The two Rs have previously been attacked for their sloppy use of statistics and misleading claims on the impact of high public debt on growth (see my post, https://thenextrecession.wordpress.com/2013/04/24/the-two-rrs-and-the-weak-recovery/). But there is no dispute about the size and growth in private sector debt, as households took out mortgages to get homes while family incomes stagnated and corporations expanded their debt as when profitability struggled, particularly after the late 1990s. As R&R put it:” Unlike central government debt, where the series are remarkably stationary over a two century period, private sector shows marked upward trend due in financial innovation and globalization, punctuated by volatility due to periods of financial repression and financial liberalization. As the figure shows, the degree of deleveraging post financial crisis has been limited. In essence, this is because the advanced countries have exercised the government’s capacity to borrow even after a crisis to prop up the system. This strategy likely made the initial post-crisis phase less acute. But it also implies that it make take more years to ultimately deleverage.”
The two Rs claim that historically, “economic activity following financial crises tends to be anemic, especially when the preceding economic expansion was accompanied by rapid growth in credit and real estate prices. Weak recoveries from financial crises reflect, in part, the process of deleveraging and balance sheet repair: Households pull back on spending to recoup lost wealth and reduce debt burdens, while financial institutions restrict credit to restore capital ratios and reduce the riskiness of their portfolios.”
We are now being told by the likes of Ben Bernanke and the mainstream economists of AEA that things are looking better. Bernanke again: “The combination of financial healing, greater balance in the housing market, less fiscal restraint, and, of course, continued monetary policy accommodation bodes well for U.S. economic growth in coming quarters. But, of course, if the experience of the past few years teaches us anything, it is that we should be cautious in our forecasts.”
Well, yes indeed – be cautious. Because if history is any guide, there are many more years of excessive debt to be deleveraged. The impact of excessive credit and the financial panic is not over as Bernanke hopes. And anyway, it appears that capitalist accumulation is now at a pretty low ebb and insufficient to restore economic growth and employment back even to pre-crisis levels, let alone that of the 1960s. Bernanke (and mainstream economic policy) has failed.
Firms have an opportunity to “clean out” labor and the wage structures during a recession. Firms are able to establish a new level of labor share. Then this new level of labor share in effect solidifies (rigidifies?) as the business cycle recovers. Thus, it is actually difficult to change labor share outside of the recessionary part of the business cycle.
Labor share can only shift so much during a recession due to wage rigidities and “depth of recession” time. Rigidities can be cleaned out more during a deep recession. We can see that labor share was only able to shift a little during the 2001 recession. That recession was not as deep and long as the recent crisis recession.