Thursday, August 11, 2011

Why Keeping Interest Low Won't Save The Economy

As the old saying goes - expecting different results while repeating the same act over and over again is a sign of psychosis. That, however, has never stood in the way of government policy where bureaucratic inertia, the desire of the ruling class to continue in the ways that have worked in the past, and plain old electoral opportunism tend to reinforce the idea of using the same basic policy tools even after they're well past its best before date. So it is with the response of the US Federal Reserve Bank, the Bank of England and even the Bank of Canada, to the present round of bad economic data and the downgrading of US debt. And, yes, it is a sign of social and economic psychosis.

But first, it's useful to summarize the state of the economy. To return to the UK, USA and Canada what we see is, at best, growth so slow that it is almost a stall. In Canada the last quarter saw the economy shrink by o.4 percent. In the USA there was some cheer at last week's announcement that the economy created some 170, 000 jobs and the unemployment rate declined from 9.2 to 9.1 percent. Except that the only reason that there was a decline, and not an increase, was because 200,000 people gave up looking for work altogether. The Bank of England has now lowered forecasts of growth to below two percent for this year and with next year barely reaching two percent (Frankly, I think, given the austerity being imposed by the Tory-Lib Dem coalition government, this is either naive optimism or an attempt to calm the markets and give support to the program of cuts).

I've discussed the cause of the crisis elsewhere as being rooted in the decline of the rate of profit over an extended period since the 1970s. One expression of that decline has been the increasing financialization of the economy and the growing centrality of debt fuelled growth that has seen an almost unbroken increase in debt levels - both public and private - since the Reagan years. Most mainstream economists, even progressive ones, see the debt situation as a question of accumulated problems as a result of bad policies - too much spending on social programs, cuts to taxes, too much stimulation of speculative/real estate/commodity bubbles, etc. Nouriel Roubini, an astute and widely respected mainstream economic, for instance, writes the following (website requires registration):
The subpar growth of most advanced economies has been ongoing since the recovery started in mid-2009. The crisis was caused by too much debt and leverage (my emphasis) in the private sector (households, banks, financial institutions and even the fat tail of the corporate sector) and then in the public sector (following stimulus, automatic stabilizers and bailouts of the financial system); and now a painful process of deleveraging—spending less in the private and public sectors to increase savings or reduce dissavings—to reduce debts and leverage has led to a weak, U-shaped recovery from a balance-sheet-crisis-driven recession, rather than the typical V-shaped recovery that occurs after plain vanilla recessions caused by monetary tightening following overheating growth.
Nobel Prize-winning economy Joseph Stiglitz, writing in the Financial Times, writes approximately the same diagnosis as Roubini when he says:

Pre-crisis, America, and to a large extent the world economy, was sustained by a bubble. The breaking of the bubble has left a legacy of excess leverage and real estate. Consumption will therefore remain weak and austerity on both sides of the Atlantic now ensures the state will not fill the void. Given this, it is not surprising that companies are unwilling to invest – even those that can get access to capital.
Again, this is roughly true in terms of the symptom but, lacking a deeper analysis of the real causes of the crisis has its own problems, to which I'll return in a future post. However, if we assume for a moment that the problems we now face are the result of the whole economy - households, financial institutions, companies and governments - being overleveraged (i.e. deep in debt). And if that is the result of encouraging the formation of a speculative bubble - first in dot com stocks at the end of the 90s and then, at an even higher level, in real estate and various forms of "asset backed securities" or "collateralized debt obligations" throughout the first decade of this century. If all that is true then doesn't it seem utterly insane that the only response to the present crisis is that the Fed, the Bank of England, and the Bank of Canada have sworn to keep real interest rates at zero, thus encouraging another bubble (at worst) or, at the very least, encouraging people who are already tapped out to take on more debt.

Of course, there is a certain logic here: governments want to get rid of their debts. But those debts are by and large accumulated as a result of providing services paid for by taxation (well, until taxes for the wealthy were repeatedly cut, drastically reducing tax revenues). Reducing government debt means cutting services like healthcare or community centres or unemployment insurance benefits. That money has to be made up somewhere else, which means that consumers have to take out more comprehensive health insurance policies - either negotiated through their collective agreement or paid for by cash-strapped households - leading to an increase of debt by households. So, there is a certain logic here - cutting services means that workers can only keep their heads above water by taking on more debt. To make that possible in the context of reduced demand - as a result of cuts in government spending - requires that affordable debt be available.

As a result, rather than encouraging economic growth for most of the population, it is possible that the continuation of historically low interest rates, rather than spurring on growth will simply allow a delay in the day of reckoning. There will be no benefit to growth because cuts to government spending - as demonstrated by the International Monetary Fund - lead to a reduction in GDP. And the further accumulation of debt means that consumers - who make up 70% of GDP in North America - will be unable for a longer period of time to drive growth. If this sounds like a large scale form of kiting - shifting debt from one place to another by writing cheques that will bounce on one bank account but then writing a cheque from another bank account (that will also bounce) to stop the first cheque from bouncing - then, you're right. The present austerity is absolutely that: kiting.

What the Fed's announcement that it will keep real interest rates at zero demonstrates is the absolute poverty of alternatives at the governmental level. Part of the problem is that there is no real pressure from below by strikes, occupations, etc - to push for a different response. Part of it is that the ruling class - and the working class - will always try to resolve problems in the way that problems have been resolved in the past. We always seek the path of least resistance. There are other ways to "solve" the problem of long term economic stagnation or inflation or deflation, etc. But those ways are out of the ordinary - they are tools like war, hyper-inflation, fascism and dictatorship - from the side of the capitalists - or revolutionary struggles, strike waves, mass civil disobedience - from the working class. But to choose those alternatives, to make them even something that could even be contemplated, requires that the relative classes must feel that no other alternative is on offer and that their existence is threatened. We're certainly not there yet - though we're beginning to see the glimmerings of that conversation in the mainstream media - and so, instead, what we have is the increasing madness of proposing the same solutions to solve problems that they have proven utterly incapable of solving in the past.
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