Currency and Bank Notes Act, 1914: ‘A Bill, To authorise the issue of Currency Notes, and to make provision with respect to the Note Issue of Banks’.
Issued one day after Britain declared war on Germany, this act permitted the Government to print notes as legal tender in place of gold sovereigns and half-sovereigns. By withdrawing gold from internal circulation, this Act effectively suspended the gold standard and in practice allowed for an inflationary expansion of the money supply enabling the Government to print notes to cover its obligations. Consequently, the Act gave the Government, operating through the Bank of England, great latitude to the Bank of England in issuing notes beyond the limit authorised by law. The Royal Mint continued to mint gold sovereigns until 1917, although with the issuance of large amounts of paper money, gold coins were soon withdrawn from circulation.
——— Be it enacted by the King’s most Excellent Majesty, by and with the advice and consent of the Lords Spiritual and Temporal, and Commons, in this present Parliament assembled, and by the authority of the same, as follows:
1 — (1) The Treasury may, subject to the provisions of this Act, issue currency notes for one pound and for ten shillings, and those notes shall be current in the United Kingdom in the same manner and to the same extent and as fully as sovereigns and half-sovereigns are current and shall be legal tender in the United Kingdom for the payment of any amount.
(2) Currency notes under this Act shall be in such form and of such design and printed from such plate and on such paper and be authenticated in such manner as may be directed by the Treasury.
(3) The holder of a currency note shall be entitled to obtain on demand during office hours at the Bank of England payment for the note at its face value in gold coin, which is for the time being legal tender in the United Kingdom.
(4) The Treasury may, subject to such conditions at to time, manner, and order of presentation as they think fit call in any currency notes under this Act on paying for those notes at their face value in gold.
(5) Currency notes under this Act shall be deemed to be bank notes within the meaning of the Forgery Act, 1913, and any other enactment relating to offences in respect of bank notes which is for the time being in force in any part of the British Islands, and to be valuable securities within the meaning of the Larceny Act, 1861, and any other law relating to stealing which is for the time being in force in any part of the British Islands, and to be current coin of the realm for the purpose of the Acts relating to truck and any other enactment.
(6) For the purpose of meeting immediate exigencies all postal orders issued either before or after the passing of this Act shall temporarily be current and legal tender in the United Kingdom in the same manner and to the same extent and as fully as current coins, and shall be legal tender in the United Kingdom for the payment of any amount. The holder of any such postal order shall be entitled to obtain on demand during office hours at the Bank of England payment for the postal order at its face value in any coin which is for the time being legal tender in the United Kingdom for the amount of the note. Provisos (b) and (c) to subsection (1) of section twenty-four of the Post Office Act, 1908, shall not apply to any such postal orders. This subsection shall have effect only until His Majesty by proclamation revokes the same, and any proclamation revoking this subsection may provide for the calling in or exchange of any postal orders affected thereby.
2. Currency notes may be issued to such persons and in such manner as the Treasury direct, but the amount of any notes issued to any person shall, by virtue of this Act, and without registration or further assurance, be a floating charge in priority to all other charges, whether under statute or otherwise, on the assets of that person.
3. The governor and company of the Bank of England and any persons concerned in the management of any Scottish or Irish Bank of issue may, so far as temporarily authorised by the Treasury and subject to any conditions attached to that authority, issue notes in excess of any limit fixed by law; and those persons are hereby indemnified, freed, and discharged from any liability, penal or civil, in respect of any issue of notes beyond the amount fixed by law which has been made by them since the first day of August nineteen hundred and fourteen in pursuance of any authority of the Treasury or of any letter from the Chancellor of the Exchequer, and any proceedings taken to enforce any such liability shall be void.
4. Any bank notes issued by a bank of issue in Scotland or Ireland shall be legal tender for a payment of any amount in Scotland or Ireland respectively, and any such bank of issue shall not be under any obligation to pay its notes on demand except at the head office of the bank, and may pay its notes, if thought fit, in currency notes issued under this Act: Provided that notes which are legal tender under this section shall not be legal tender for any payment by the head office of the bank by whom they are issued for the purpose of the payment of notes issued by that bank. This section shall have effect only until His Majesty by proclamation revokes the same, and any proclamation revoking this section may provide for the calling in or exchange of notes affected thereby.
5.— (1) In this Act, the expression “bank of issue” means any bank having power for the time being to issue bank notes. (2) This Act may be cited as the Currency and Bank Notes Act, 1914. (3) This Act shall apply to the Isle of Man as if it were part of the United Kingdom, but shall not apply to any other British possession.
——— Source: Great Britain, Parliamentary Papers, House of Commons, 1914, 361, vol. 1.
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An Act to amend the Currency and Bank Notes Act, 1914 [28th august 1914] Be it enacted by the King's most Excellent Majesty, by and with the advice and consent of the Lords Spiritual and Temporal, and Commons, in this present Parliament assembled, and by the authority of the same, as follows: 1. The power of the Treasury to call in currency notes under subsection (4) of the section one of the Currency and Bank Notes Act, 1914, shall be extended so as to include a power to call in currency notes, on exchanging the notes so called in, for other notes of the same face value issued under that Act. 2. The Treasury may, if they think fit, instead of issuing any notes to any person, give to that person a certificate entitling him to the issue, on demand from the Treasury, of the notes mentioned in the certificate; and the notes covered by the certificate shall, for the purposes of section two of the Currency and Bank Notes Act, 1914, be deemed to be notes issued to that person. 3. This Act may be cited as the Currency and Bank Notes (Amendment) Act, 1914.
------Source: House of Commons, House of Commons parliamentary papers, 1914 (London: House of Commons, 1914), vol. 1, pp. 873-6.
PRIVATE PARTY Extract from Bean Counters: The Triumph of the Accountants and How They Broke Capitalism Central to New Labour’s election victory was renouncing high taxes and committing to sound public finances. These twin new commitments were enshrined in a self-imposed limit on government debt. But the party had also distinguished itself from the Tories by promising to improve public services that had been starved of investment. This created a fiscal conundrum. How was the extra spending to be funded without extra borrowing? The answer was something called the private finance initiative (PFI), which had been devised by the previous government but used only to a limited extent for some road extensions and a couple of prisons. The new government would put all its infrastructure eggs in the PFI basket, no longer paying for major projects out of taxes or borrowings. Consortia of banks, construction companies and service providers would borrow the money, construct the school, hospital or other facility and then make it available to the relevant public service under a long-term agreement. The magic in the scheme was that the taxpayer’s commitment to pay fees for using the new infrastructure every year, typically for thirty years, would not usually count as government borrowing. The scheme would be ‘off the books’. Under cautious government rules, such helpful accounting was strictly possible only if the taxpayer was not on the hook if the scheme went wrong. The Tories had accordingly insisted that the private companies bear all the risks of any deal, which had limited PFI’s appeal to the bankers and builders on whose involvement the scheme depended. So when he took office, anxious to deploy PFI for hospital- and school-building programmes, Gordon Brown set about making it more attractive to them. Under a special task force containing two consultants from Price Waterhouse and one from Coopers & Lybrand working on the all-important accounting, the rules were relaxed. 2 Private companies would be able to shoulder fewer risks, while the government would keep its essential off-the-books accounting. Not for the first – or last – time, the bean counters had written the rules of a game they would go on to play very profitably. The other knotty problem was that, under a long-standing parliamentary principle, large projects could be signed only if they gave value for money. This was tricky when the price to be paid to the private PFI consortia had to include profits large enough to persuade them into lengthy deals and cover private borrowing costs, which were always higher than the government’s. PFI was inevitably far more expensive than the alternative of conventional government funding. To get over this hurdle, a series of spurious reductions would be applied to the sum of future PFI payments when comparing the cost of a proposed scheme with paying for it through government borrowing and taxation. Many were highly subjective, involving estimates of the likely costs of vague matters such as ‘operational risk’. Then there was an adjustment for ‘optimism bias’, on the soon-discredited assumption that traditional procurement ran significantly more over-budget than PFI. There was even a large discount for tax payments that the private companies operating PFI schemes would supposedly make but in reality did not. It was devised by KPMG at the same time as the firm was advising the PFI companies on how to avoid their tax liabilities. This usually involved treating the costs of building schools or hospitals not as an asset on the PFI company’s balance sheet but as an ongoing expense, which attracted greater tax relief. Many of the country’s largest new hospitals were thus taken off both the government’s and the PFI companies’ books, dispatched to an accounting fourth dimension. One Tory MP (and chartered accountant) taunted Gordon Brown with some justification that he had become the ‘Enron Chancellor’. 3 The fiddles achieved the desired result. Over Labour’s first two terms in government, more than 400 deals for infrastructure worth £25bn were signed (the figure now stands at about £60bn worth, costing £10bn a year for another generation). 4 The complex contracts required the services of financial consultants, almost always from KPMG, PwC, Deloitte or Ernst & Young, on each side. Public bodies such as NHS trusts or local education authorities, for whom each deal was a once-in-a-generation event, were especially dependent on their expert advice. The Big Four would ensure that their value-for-money calculations gave the ‘right’ answer and that they kept their scheme ‘off the books’. One accounting academic who advised the Treasury on PFI, later explained: ‘There became an industry in cosmetic presentation of projects.’ 5 A rich industry it was too, with fees for all advisers coming in at around £3m for an average contract, around half of which would typically go to one of the Big Four firms. 6 By 2014, the same academic reckoned that the Big Four had earned £1bn from the private finance initiative. Small wonder they had been so keen to push it in the first place. Conflicts of interest proliferated, the bean counters often advising public bodies on signing deals with companies that were also their clients for auditing and consulting services. And with the government’s task force recommending ‘success fees’ for advisers, including the major accountancy firms represented on the task force, the incentive was to get the deal done. There is no trace of any advice that a scheme wouldn’t be such a smart idea. 7 Getting the contract through often involved blatant manipulation, with the cost of a PFI deal usually ending up just a few pounds better value than the publicly funded alternative. In one case reported by the National Audit Office public spending watchdog, a new £130m hospital at West Middlesex had at first appeared to be more expensive to build under PFI. But the trust’s adviser, KPMG, had convened a series of ‘risk workshops’ to identify some more convenient risks associated with the public sector alternative. Hey presto, the PFI deal came out slightly cheaper. 8 The accountancy firms naturally became highly protective of their new golden goose. When critics attacked the early hospital deals – on which financial engineering took precedence over design quality, and extra costs immediately led to fewer beds for the sick – New Labour’s friends at Arthur Andersen & Co. stepped in with a study, in 1999, concluding that PFI schemes came in cheaper than others. It was soon discredited, mainly because it ignored large cost escalations after schemes had been agreed but before they were signed. 9 The leading PFI consultant, PwC, rode to the rescue with another supposedly ‘independent’ report. It was no more than a summary of testimonials from officials who had signed PFI contracts and were not about to admit they had thrown the taxpayer’s money away. Yet it became an official endorsement. When Prime Minister Blair was confronted in Parliament in 2002 with PFI’s shortcomings, he simply referred his questioner to ‘the PricewaterhouseCoopers report on the PFI, which found that it was excellent value for money’. 10 It certainly was for the bean counters, who as so often were paraded as independent authorities on areas from which they were getting very rich. Meanwhile, the holder of the national public purse strings, Gordon Brown, was ensuring that Whitehall’s biggest investment decisions would be taken by PFI consultants from the Big Four firms rather than civil servants who might be more circumspect. KPMG’s head of infrastructure,Dr Timothy Stone, a former physical chemist who moved into consulting through Arthur Andersen and was known by some as the ‘sage of PFI’, became especially powerful. He could be found variously in the Department of Health’s commercial directorate, at the education department advising on the schools rebuilding programme, on the government’s ‘sustainable procurement’ task force and as permanent adviser to the Ministry of Defence on the biggest PFI scheme of them all, a £10bn project for in-flight jet-refuelling aircraft. ‘I wear many hats,’ the KPMG man would later admit. 11 Special PFI units inside the key government departments across Whitehall were all handed to consultants on secondment from the Big Four. In 2005, PwC bean counter Richard Abadie took over the central Treasury PFI Unit for a couple of years, delivering a 30% growth in the number of deals signed. 12 A few years later, back running PwC’s private finance practice (and having been succeeded at the Treasury by a Deloitte bean counter), Abadie was summoned by a sceptical committee of MPs. Would he ‘be willing to submit some aggregate numbers for the amounts of money [PwC] have earned on PFI in this country over the last 10 years?’ asked one. ‘Probably not,’ replied Abadie. ‘I believe that is commercially confidential.’ 13 Just like the other accountants’ ramps, even if the public were paying a heavy price, PFI was a private affair. DISASTER MANAGEMENT In 2008, after a five-year delay, the jet-refuelling scheme on which KPMG’s many-hatted Dr Stone had advised eventually went ahead. It soon became clear that the 27-year Future Strategic Tanker Aircraft contract had lumbered the armed forces with overpriced planes that weren’t even fit for ‘high-threat areas’: something of a drawback in military aircraft. The fiasco prompted one of the National Audit Office’s most damning reports on a major public contract, complete with the ‘not value for money’ black spot. The deal, said the watchdog, had been struck ‘without a sound evaluation of alternative procurement routes to justify why the PFI route offered the best value for money’. 14 Since KPMG’s top PFI man had been in charge, this wasn’t too surprising. In 2010, the outcome was summed up by the chairman of Parliament’s public accounts committee at the time, Sir Edward Leigh. ‘By introducing a private finance element to the deal,’ he concluded, ‘the MoD managed to turn what should have been a relatively straightforward procurement into a bureaucratic nightmare.’ 15 Still, a ‘bureaucratic nightmare’ is a consultant’s dream, and with the taxpayer handing over £10m for ‘finance, tax and accounting advice’, once again the bean counters led by Dr Stone came out on top. Nor did the affair harm the head of the MoD’s PFI unit who had signed off the deal, Nick Prior. By the time the extent of the waste was exposed, he had stepped through the well-oiled revolving door between Whitehall and the PFI industry to be Deloitte’s ‘global head of infrastructure’. There he rejoices in the role of ‘lead client service partner’ for the Ministry of Defence. 16 Even with PFI and the big accountancy firms’ role in it largely discredited, the scheme remains another gift from the taxpayer that keeps on giving to the bean counters. When hospital trusts saddled with overpriced PFI contracts inevitably ran into trouble after a few years, the Big Four would be back on the scene selling remedies for the ill-effects of their own snake oil. By 2013, the biggest health PFI scheme, a £1.1bn redevelopment at St Bartholomew and Royal London, was eating up £120m a year of the trust’s budget, plunging it into a deficit of around £50m and forcing thousands of job cuts. In came PwC as ‘turnaround’ specialists, even though the same firm had advised the trust on signing the PFI deal in the first place seven years earlier. Back then, even the trust’s chairman had admitted: ‘If this was the private sector, you’d be in jail. This is what got Enron into trouble. It’s all off the balance sheet. It’s cloud-cuckoo land, Alice in Wonderland stuff.’ 17 Yet not only did PwC go on to earn fees for the remedial financial advice, they then sold the hospital a ‘sustainable operational efficiency and improvement programme’. While the hospital cut thousands of jobs, the firm was shortlisted – without irony – for a Management Consultancies Association award in the ‘performance improvement in the public sector’ category. 18 Across Britain, the bean counters continue to clean up from the financial mess left by PFI bills that will demand payment before doctors’, nurses’, teachers’ and armed forces personnel’s wages for another generation. In 2013, six years after PwC told Peterborough hospital that a £400m PFI scheme was ‘competitive, robust and demonstrate[s] value for money’, the public accounts committee labelled it ‘catastrophic’. By this time PwC was back in there earning £3m a year from telling the trust how to deal with the £45m annual deficit caused by the contract. 19 Up in Northumbria, Deloitte advised the trust running Hexham General Hospital on how to buy itself out of a financially ruinous PFI deal that KPMG had advised it on back in the late 1990s. So expensive had the contract turned out that the trust could pay the PFI company tens of millions of pounds in compensation and still save money. 20 PFI became a huge public sector money-spinner for the Big Four accountancy firms and played a key role in ensconcing them in Whitehall. Once inside, they began creating a more enduring legacy. It would go well beyond the bricks and mortar and into the transformation of public services themselves. Notes: 2. The consultants on the PFI task force were Ben Prynn and David Goldstone from Price Waterhouse and Tony Whitehead from Coopers & Lybrand. 3. Hansard, 2 April 2003, Col. 285WH. 4. From PFI summary data published annually by HM Treasury. 5. Comments from Professor David Heald, Aberdeen University, in Radio 4 File on 4 programme ‘The Accountant Kings’, broadcast 4 March 2014. 6. Public Accounts Committee report, HM Treasury: Tendering and Benchmarking in PFI, 27 November 2007. 7. Treasury Taskforce Technical Note 3: How to Appoint and Manage Advisers to PFI Projects, https://ppp.worldbank.org/public-private-partnership/sites/ppp.worldbank.org/files/documents/How%20to%20Appoint2017%20and%20Manage%20Advisers accessed 9 March 2017. 8. The PFI Contract for the Redevelopment of West Middlesex University Hospital, National Audit Office, 21 November 2002. 9. Professor Allyson Pollock, then of the Centre for International Public Health Policy at the University of Edinburgh, produced a number of papers taking apart the ‘evidence’ of those linked to PFI schemes. A good summary of the flaws of the Arthur Andersen report can be found in her evidence to Parliament’s Health Select Committee on 14 April 2000, available at http://www.publications.parliament.uk/pa/cm200102/cmselect/cmhealth/308/308ap30.htm; accessed on 16 September 2016. 10. Hansard, 30 January 2002, Col. 286. 11. Evidence of Dr Timothy Stone to House of Lords Economic Affairs Committee inquiry into Private Finance Projects and Off Balance Sheet Debts, 13 October 2009. 12. Based on 47 deals signed in 2004/5 and 61 signed in 2007/8, data from HM Treasury ‘current projects’ dataset. 13. Evidence to House of Commons Treasury Select Committee on Private Finance Initiative, 14 June 2011. 14. ‘Delivering the Multi-role Tanker Aircraft Capability’, National Audit Office, 30 March 2010. 15. BBC report, 30 March 2010, http://news.bbc.co.uk/1/hi/uk/8593788.stm. 16. Nick Prior, LinkedIn profile, accessed 16 September 2016. 17. Reported in Andrew Hankinson, ‘NHS Boss Dubs PFI “Alice in Wonderland stuff”’, Construction News, 22 September 2005, and in Private Eye magazine, issue 1200, December 2007. 18. https://www.mca.org.uk/library/documents/PI_Pub_-_PwC_with_Barts_NHS.pdf. 19. Public Accounts Committee report, Hinchingbrooke Health Care NHS Trust, Peterborough and Stamford Hospitals NHS Foundation Trust, 7 February 2013. The background to the 2007 signing of the contract given in report by Caroline Molloy on Open Democracy website, 19 September 2013, https://www.opendemocracy.net/ournhs/caroline-molloy/peterborough-hospital-nhs-and-britains-privatisation-racket; accessed 18 September 2016. 20. Gill Plumber and Sarah Neville, ‘NHS Trust Becomes First to Buy out its PFI Contract’, Financial Times, 1 October 2014.
Treasury-issue £1 note, also known as a 'Bradbury', 1917
At the outbreak of war in August 1914, one of the government’s first
priorities was to withdraw gold from the circulating economy so that it
could be put towards the national war effort. Moreover, hoarding of gold
and silver coin was widespread, impeding normal small payments. To
ensure that people still had cash in their tills and pockets, the
government needed to introduce paper money instead.
In Scotland banknotes were already widely used, but in England and
Wales the picture was very different. The Bank of England issued notes
for values of £5 and up, but this was a large sum of money, comparable
to more than £400 today. Most people never saw or used banknotes at all.
In order to replace gold coins effectively, a large supply of notes
had to be made available for values of £1 and 10 shillings (that is,
half a pound). The Bank of England could not prepare and print the
required number of notes quickly enough, so the government took the
unprecedented step of deciding to issue the notes itself. They would be
called Treasury notes or, unofficially, 'Bradburys', after the signature
they bore of Sir John Bradbury, permanent secretary to the Treasury.
They would be legal tender, meaning that they had to be accepted when
offered in payment of a debt; the creditor couldn’t hold out for gold.
Designs were drawn up over the weekend of 1-2 August 1914. They were
delivered to the printer on Tuesday 4 August, the day Britain entered
the war. The engraved vignette was borrowed from an existing one at the
Royal Mint, and the notes were printed on postage stamp paper – the only
ready supply available at the time. After two days of round-the-clock
printing, £2.5m of new £1 notes were distributed to banks on Thursday 6
August 1914, ready for when they reopened on Friday. The £1 notes got
them through the immediate crisis, and the 10s notes – useful for
smaller transactions – were ready a week later.
The great haste with which the notes were prepared was necessary in
the immediate crisis, but led to subsequent problems for anyone handling
cash, including bank clerks. For one thing, the notes were small,
measuring less than 13x7cm – smaller than a modern £5 note. In contrast,
a Bank of England £5 at that time was about the size of a paperback
book cover. In Parliament one MP likened them to ‘lottery tickets’.
Their small size made them difficult to handle. One Ulster Bank clerk
complained, ‘the operation of dealing with a large number of 10/- notes
is a severe test even to a sleight-of-hand artist. In short the notes
are too small for rapid manipulation.’
There were also problems with forgery. The hasty design had made it
impossible to incorporate effective anti-counterfeiting measures. Worse
still, in England and Wales people were not used to handling banknotes,
so didn’t know how to spot a fake. Furthermore, people were moving
around the country more than in peacetime. Shopkeepers and bank clerks
found themselves dealing with strangers, making it easier for forgers to
pass their work into circulation unnoticed.
‘Forgeries’ were not always the result of criminal intent. In 1915,
there was a flurry of cases of companies issuing advertising flyers in
the style of treasury notes. Meant as eye-catching topical references,
some were very similar to the notes they copied, and actually found
their way into circulation, either deliberately or by accident.
Despite the difficulties, Treasury notes played a vital role in
keeping the economy moving during the First World War. For the first
time in England and Wales, paper money became normal currency, used by
ordinary people. After the war, its use continued. Treasury notes were
issued until 1928, and thereafter the Bank of England took over
responsibility for issuing £1 and 10s notes.
$100 notes are printed at the U.S. Bureau of Engraving and
Printing in Washington, D.C., on May 20, 2013. Mark Wilson/Getty Images
In a post-Great Recession world, monetary policy just looks
different. For one thing, central bank independence is dead—but the U.S.
Congress doesn’t know it yet. We could argue for hours, or days, about
whether it ever really existed or when exactly it died, but suffice to
say that the moment quantitative easing started, the Federal Reserve
stepped out of its well-defined monetary box, and independence was no
more. Central bankers know it: In a recent survey,
61 percent of former central bankers surveyed from around the world
predicted that central banks would be less independent in the future.
The U.S. Congress has not acknowledged this reality. Members of
Congress depend on the doctrine of central bank independence to keep the
dirty business of monetary policy off their hands. The question is
whether Congress will continue to ignore reality and let the Fed take on
more power—and increasingly fiscal rather than just monetary—over the
economy or whether it will choose to step in, reassert its political
power, and get more involved. Most important of all is a question no one
seems willing to ask: What might the answer to this question say about
the state of U.S. democracy?
The Fed’s policymaking power comes from its congressional mandate
“to promote effectively the goals of maximum employment, stable prices,
and moderate long-term interest rates.” That’s a pretty vague mandate.
Imagine the range of policies that might influence employment, price
stability, and interest rates: job creation, education, health care,
climate change, electoral politics, the list goes on. Prior to the 2008
financial crisis, the Fed’s delegated powers were restricted by a set of
informal limitations. Namely, the Fed, an independent central bank
populated by experts, would execute monetary policy according to
internationally accepted best practices. But the crisis exploded the
conventional consensus on best practices and, in so doing, broke the
restrictions on the Fed’s power. That’s a problem. As Paul Tucker, a
former deputy governor of the Bank of England, wrote in 2018,
without clarity on the limits of their power, central bankers would “be
incentivized to do whatever is needed to deliver their mandate, however
far that reaches into fiscal territory.”
One of the initiatives they tried during the financial crisis
was quantitative easing. After conventional approaches, like
manipulating the short-term interest rate, proved insufficient, they
turned to QE. QE is a form of large-scale asset purchase in which the
Fed buys a huge number of longer-term government-backed securities using
newly created central bank reserves in an effort to change the contours
of the market. Although the world is a decade past the crisis, central
banks have struggled to restore conventional policy. The post-2008
economy is not like the pre-2008 economy. In particular, policymakers
are staring down the barrel of persistently low natural real interest
rates and the realization that inflation seems to be determined more by
inflation expectations than by real economic slack. The upshot of this
new economic environment is that, from now on, conventional monetary
policy will not be sufficient to maintain price stability.
In June, the Fed convened a conference to address the problem. In his
opening remarks, Federal Reserve Chair Jerome Powell posed three
guiding questions that can be summed up in one: How can the Federal
Reserve continue to reach its stated aims in the face of this new
economic environment, taking existing governance structures as given? He
went on to suggest an answer:
“Perhaps it is time to retire the term ‘unconventional’ when referring
to tools that were used in the crisis.” This was more or less the
prevailing theme of the entire conference: Make the unconventional
conventional. In other words, quantitative easing will be part of the
new normal. That’s already started to happen. Take one example: The New
York Fed recently implemented large repurchase agreement operations,
essentially launching a targeted version of QE to prevent the collapse
of one far-away corner of the financial markets with a liquidity
problem. This has gone largely unnoticed in the public domain. There are two ways to interpret the Fed’s so-called normalization of the abnormal.
There are two ways to interpret the Fed’s so-called normalization of the abnormal.
It is either a power grab or an administrative agency doing its best to
fulfill its congressional mandate in a new economic environment. In
reality, it is probably both. The fact that such blatant overreach is
necessary should perhaps tell us something about the job itself, the
state of the economy, and the state of the U.S. democracy. Under either
interpretation, Congress is shirking its responsibility to govern the
macroeconomy by allowing the Fed to redraw the boundaries of its own
policy jurisdiction.
Money is the stuff of our collective life. It is what binds us
together as citizens; it determines who is permitted to do what in
society, what society values, what it wishes to create, and much more.
Money represents our social, economic, and political interdependence.
The central bank is not the only institution that creates money. Banks
do. Every time a bank extends credit, it creates money. The Fed’s power
over the money supply, then, is not all about choosing how many dollars
to print. In large part it comes from the Fed’s ability to incentivize
banks to extend more or less credit, on easier or more stringent terms.
Right now, the Fed’s monetary authority—the Federal Open Market
Committee—is made up of only 10 people: All are white, none are elected.
Both conventional and unconventional monetary policy involve open
market operations, in which the Fed executes monetary policy by buying
or selling assets on the so-called open market. The use of the term
“open market” here is a bit misleading. Whenever the Fed buys and sells
Treasurys in order to execute monetary policy, it interacts with a
predetermined set of primary dealers. There are about 20 designated
primary dealers at any given time. The list changes fairly regularly and
is not limited to U.S.-owned financial institutions. Today’s primary
dealers include BNP Paribas; Barclays; Bank of Nova Scotia, New York
Agency; BofA Securities; Citigroup Global Markets; and Goldman Sachs, to
name a few.
The expectation is that the Fed’s buying and selling Treasurys to and
from primary dealers will stimulate the entire economy. The enormous
asset purchases the Fed made from primary dealers as part of QE were
meant to encourage investors to put their money in riskier assets and
thereby reduce the cost of borrowing across the economy. It was up to
the investors, of course, to decide which assets to invest in, when, how
much, and why. In sum, trickle-down economics is alive and well in U.S.
monetary policy.
To see how, consider that when the United States creates new money,
whether through QE or more conventional channels, it disseminates that
money through private financial institutions run by individuals who are
extremely rich and are explicitly profit-seeking. These financial
institutions decide how much money to create, whom to extend credit to,
and on what terms. These same private financial institutions have a
history of disseminating credit to the rest of the population in a highly lopsided manner.
The U.S. approach to governing money leaves much to be desired. The
public does not decide democratically what it values or wishes to
create—instead, it lets Fed officials and private financial institutions
do that on its behalf.
The Fed’s recent efforts to normalize QE will only make things worse.
The locus of power over monetary policy is drifting further and further
away from the people and their elected representatives. This poses a
threat to U.S. democracy. That should be no surprise, really, because it
means unelected bureaucrats taking on more power and responsibility
while elected officials continue to shirk.
Perhaps this system is the best option. In today’s world, one must at
least entertain the idea that a good bureaucratic policy is better than
a bad democratic one. From one vantage point, technocratic monetary
policy has come to the United States’ rescue, especially when contrasted
with the Trump administration’s abysmal policies on the environment,
taxes, the provision of public goods, and more. The Fed, for its part,
is starting to focus more and more on the fight against inequality, and
elsewhere in the world central banks are beginning to turn their
attention to addressing climate change. To steal a phrase from a recent
opinion piece in the New York Times, civil servants are sexy—“they are heroes of the resistance.”
The idea of the heroic bureaucrat is not new in monetary policy, a
sector dominated by the idea that expert technocrats can implement
optimal policy. As four former Fed chairs wrote in a piece in the Wall Street Journal
this past August, “History, both here and abroad, has shown repeatedly …
that an economy is strongest and functions best when the central bank
acts independently of short-term political pressures and relies solely
on sound economic principles and data.”
Good technocratic monetary policy, in other words, is not an
opportunity to be missed. It is a unicorn in economic theory: a free
lunch. In the short run, according to conventional theory, monetary
policy can be used to stabilize aggregate demand to meet aggregate
supply, thereby dampening business cycles and achieving price stability.
In the long run, monetary policy is nothing more than deciding the
price of money, thereby influencing how much money is in the system—if
bread costs $1 or $100. Monetary policy is assumed to have no lasting
effect on output or unemployment and, thus, no real cost. The
conventional view can be summed up as follows: Fiscal policy is what
shapes the real economy; monetary policy merely matches it. Or as one Bloomberg commentator put it, “the point of the Fed is to read and react.”
This is all very neat and tidy, but what does monetary policy acting
only to match the real economy actually look like? It’s more complicated
than you might think. Take the example of U.S. President Donald Trump’s
recent war with the Fed. Trump is not only berating the Fed on Twitter,
he is also creating an economic world in which his coveted lower
interest rates actually make sense. His trade war with China has
contributed to an economic environment in which the Fed, relying “solely
on sound economic principles and data,” would likely lower rates. Trump
has contributed to the development of an economic situation in which,
on the numbers alone, it makes sense for the Fed to what exactly what
Trump demands it does: lower rates.
In such a situation, what should the Fed do? Should it comply? Or
should the Fed refuse to play along with the president in pursuit of
longer-term price stability—that is, not lower rates to avoid a
trade-induced economic disaster? The latter option was the forceful
suggestion of former New York Fed President and CEO William Dudley in a
now-infamous Bloomberg op-ed.
Dudley went on to suggest, “There’s even an argument that the election
itself falls within the Fed’s purview. After all, Trump’s reelection
arguably presents a threat to the U.S. and global economy.” Let’s
be clear about what this former Federal Open Market Committee member is
suggesting: The Federal Reserve, the independent central bank of the
United States, should interfere in the nation’s general election.
Let’s
be clear about what this former Federal Open Market Committee member is
suggesting: The Federal Reserve, the independent central bank of the
United States, should interfere in the nation’s general election.
Here we have a direct conflict between good bureaucracy and bad
democracy—the good bureaucrats correcting for bad democratic impulses.
As much as observers fretted over the idea that a foreign power
could, and had, interfered with the integrity of the U.S. election
system, fewer were outraged by the idea of the Fed interfering. Sure,
Russia is a foreign power, and the Fed is a U.S. institution, but when
it comes to the integrity of the democratic system, that distinction
should not really matter. What is the difference, after all, between a
sexy bureaucrat and a benevolent dictator? Both are unelected officials
who some set of observers think are doing the right thing.
To be sure, it is inevitable that some policymaking power will be
delegated to bureaucrats. There will always be unelected officials
making policy decisions that influence citizens’ lives. This is no
threat to democracy, so long as ultimate political power remains with
the people and their elected representatives. But if those officials
delegate immense power, in perpetuity, with no intention of ever
reevaluating the terms and conditions of delegation, then delegated
power starts to look increasingly like usurped power. The unelected
bureaucrat starts to look more like a dictator—benevolent or not.
Today’s political environment is forcing voters to decide how much
they really care about democracy as such. To properly answer this
question, it is important to separate out the following two questions:
Who should decide on policy? And which policies should be implemented?
For those who believe that democracy is of fundamental importance, the
who question must be prior to the which matter. In today’s political
environment, that means swallowing some awful policies—the Muslim travel
ban, the 2017 tax cuts, putting children in cages, and much more.
Given the fundamental importance of democracy, Congress should take
its fingers out of its ears and reassert its political power over
monetary policy. Some might like to see U.S. monetary policy used to
fight inequality, the perils of climate change, and existing biases in
credit allocation under the watchful eye of Congress. Others might want
it to promote political goals such as building a wall on the southern
border. In a world in which Congress wakes up and governs the economy,
rather than leaving it to the Fed, selecting from among those policies
would ultimately be in the hands of the people. That is a risk those who
believe in democracy should be willing to take. If the people are
allowed to choose only when they make the right choices, then the United
States would not be a democracy. It would be something more like the
Democratic People’s Republic of U.S. Monetary Policy.
Leah Downey is a PhD candidate in the Harvard Government department and a graduate fellow at the E. J. Safra Center for Ethics.
Dana Schutz/Petzel, New York CityDana Schutz: Men’s Retreat, 2005There
is a growing feeling, among those who have the responsibility of
managing large economies, that the discipline of economics is no longer
fit for purpose. It is beginning to look like a science designed to
solve problems that no longer exist.
A good example is the
obsession with inflation. Economists still teach their students that the
primary economic role of government—many would insist, its only really
proper economic role—is to guarantee price stability. We must be
constantly vigilant over the dangers of inflation. For governments to
simply print money is therefore inherently sinful. If, however,
inflation is kept at bay through the coordinated action of government
and central bankers, the market should find its “natural rate of
unemployment,” and investors, taking advantage of clear price signals,
should be able to ensure healthy growth. These assumptions came with the
monetarism of the 1980s, the idea that government should restrict
itself to managing the money supply, and by the 1990s had come to be
accepted as such elementary common sense that pretty much all political
debate had to set out from a ritual acknowledgment of the perils of
government spending. This continues to be the case, despite the fact
that, since the 2008 recession, central banks have been printing money
frantically in an attempt to create inflation and compel the rich to do
something useful with their money, and have been largely unsuccessful in
both endeavors.
We now live in a different economic
universe than we did before the crash. Falling unemployment no longer
drives up wages. Printing money does not cause inflation. Yet the
language of public debate, and the wisdom conveyed in economic
textbooks, remain almost entirely unchanged.
One
expects a certain institutional lag. Mainstream economists nowadays
might not be particularly good at predicting financial crashes,
facilitating general prosperity, or coming up with models for preventing
climate change, but when it comes to establishing themselves in
positions of intellectual authority, unaffected by such failings, their
success is unparalleled. One would have to look at the history of
religions to find anything like it. To this day, economics continues to
be taught not as a story of arguments—not, like any other social
science, as a welter of often warring theoretical perspectives—but
rather as something more like physics, the gradual realization of
universal, unimpeachable mathematical truths. “Heterodox” theories of
economics do, of course, exist (institutionalist, Marxist, feminist,
“Austrian,” post-Keynesian…), but their exponents have been almost
completely locked out of what are considered “serious” departments, and
even outright rebellions by economics students (from the post-autistic
economics movement in France to post-crash economics in Britain) have
largely failed to force them into the core curriculum.
As a
result, heterodox economists continue to be treated as just a step or
two away from crackpots, despite the fact that they often have a much
better record of predicting real-world economic events. What’s more, the
basic psychological assumptions on which mainstream (neoclassical)
economics is based—though they have long since been disproved by actual
psychologists—have colonized the rest of the academy, and have had a
profound impact on popular understandings of the world.
Nowhere
is this divide between public debate and economic reality more dramatic
than in Britain, which is perhaps why it appears to be the first
country where something is beginning to crack. It was center-left New
Labour that presided over the pre-crash bubble, and voters’
throw-the-bastards-out reaction brought a series of Conservative
governments that soon discovered that a rhetoric of austerity—the
Churchillian evocation of common sacrifice for the public good—played
well with the British public, allowing them to win broad popular
acceptance for policies designed to pare down what little remained of
the British welfare state and redistribute resources upward, toward the
rich. “There is no magic money tree,” as Theresa May put it during the
snap election of 2017—virtually the only memorable line from one of the
most lackluster campaigns in British history. The phrase has been
repeated endlessly in the media, whenever someone asks why the UK is the
only country in Western Europe that charges university tuition, or
whether it is really necessary to have quite so many people sleeping on
the streets.
The truly extraordinary thing about May’s phrase is
that it isn’t true. There are plenty of magic money trees in Britain, as
there are in any developed economy. They are called “banks.” Since
modern money is simply credit, banks can and do create money literally
out of nothing, simply by making loans. Almost all of the money
circulating in Britain at the moment is bank-created in this way. Not
only is the public largely unaware of this, but a recent survey by the
British research group Positive Money discovered that an astounding 85
percent of members of Parliament had no idea where money really came
from (most appeared to be under the impression that it was produced by
the Royal Mint).
Economists,
for obvious reasons, can’t be completely oblivious to the role of
banks, but they have spent much of the twentieth century arguing about
what actually happens when someone applies for a loan. One school
insists that banks transfer existing funds from their reserves, another
that they produce new money, but only on the basis of a multiplier
effect (so that your car loan can still be seen as ultimately rooted in
some retired grandmother’s pension fund). Only a minority—mostly
heterodox economists, post-Keynesians, and modern money theorists—uphold
what is called the “credit creation theory of banking”: that bankers
simply wave a magic wand and make the money appear, secure in the
confidence that even if they hand a client a credit for $1 million,
ultimately the recipient will put it back in the bank again, so that,
across the system as a whole, credits and debts will cancel out. Rather
than loans being based in deposits, in this view, deposits themselves
were the result of loans.
The one thing it never seemed to occur
to anyone to do was to get a job at a bank, and find out what actually
happens when someone asks to borrow money. In 2014 a German economist
named Richard Werner did exactly that, and discovered that, in fact,
loan officers do not check their existing funds, reserves, or anything
else. They simply create money out of thin air, or, as he preferred to
put it, “fairy dust.”
That year also appears to
have been when elements in Britain’s notoriously independent civil
service decided that enough was enough. The question of money creation
became a critical bone of contention. The overwhelming majority of even
mainstream economists in the UK had long since rejected austerity as
counterproductive (which, predictably, had almost no impact on public
debate). But at a certain point, demanding that the technocrats charged
with running the system base all policy decisions on false assumptions
about something as elementary as the nature of money becomes a little
like demanding that architects proceed on the understanding that the
square root of 47 is actually π. Architects are aware that buildings
would start falling down. People would die.
Before long, the Bank
of England (the British equivalent of the Federal Reserve, whose
economists are most free to speak their minds since they are not
formally part of the government) rolled out an elaborate official report
called “Money Creation in the Modern Economy,” replete with videos and
animations, making the same point: existing economics textbooks, and
particularly the reigning monetarist orthodoxy, are wrong. The heterodox
economists are right. Private banks create money. Central banks like
the Bank of England create money as well, but monetarists are entirely
wrong to insist that their proper function is to control the money
supply. In fact, central banks do not in any sense control the money
supply; their main function is to set the interest rate—to determine how
much private banks can charge for the money they create. Almost all
public debate on these subjects is therefore based on false premises.
For example, if what the Bank of England was saying were true,
government borrowing didn’t divert funds from the private sector; it
created entirely new money that had not existed before.
One might
have imagined that such an admission would create something of a splash,
and in certain restricted circles, it did. Central banks in Norway,
Switzerland, and Germany quickly put out similar papers. Back in the UK,
the immediate media response was simply silence. The Bank of England
report has never, to my knowledge, been so much as mentioned on the BBC or any other TV
news outlet. Newspaper columnists continued to write as if monetarism
was self-evidently correct. Politicians continued to be grilled about
where they would find the cash for social programs. It was as if a kind
of entente cordiale had been established, in which the
technocrats would be allowed to live in one theoretical universe, while
politicians and news commentators would continue to exist in an entirely
different one.
Still, there are signs that this arrangement is
temporary. England—and the Bank of England in particular—prides itself
on being a bellwether for global economic trends. Monetarism itself got
its launch into intellectual respectability in the 1970s after having
been embraced by Bank of England economists. From there it was
ultimately adopted by the insurgent Thatcher regime, and only after that
by Ronald Reagan in the United States, and it was subsequently exported
almost everywhere else.
It is possible that a similar pattern is
reproducing itself today. In 2015, a year after the appearance of the
Bank of England report, the Labour Party for the first time allowed open
elections for its leadership, and the left wing of the party, under
Jeremy Corbyn and now shadow chancellor of the exchequer John McDonnell,
took hold of the reins of power. At the time, the Labour left were
considered even more marginal extremists than was Thatcher’s wing of the
Conservative Party in 1975; it is also (despite the media’s constant
efforts to paint them as unreconstructed 1970s socialists) the only
major political group in the UK that has been open to new economic
ideas. While pretty much the entire political establishment has been
spending most of its time these last few years screaming at one another
about Brexit, McDonnell’s office—and Labour youth support groups—have
been holding workshops and floating policy initiatives on everything
from a four-day workweek and universal basic income to a Green
Industrial Revolution and “Fully Automated Luxury Communism,” and
inviting heterodox economists to take part in popular education
initiatives aimed at transforming conceptions of how the economy really
works. Corbynism has faced near-histrionic opposition from virtually all
sectors of the political establishment, but it would be unwise to
ignore the possibility that something historic is afoot.
One
sign that something historically new has indeed appeared is if scholars
begin reading the past in a new light. Accordingly, one of the most
significant books to come out of the UK in recent years would have to be
Robert Skidelsky’s Money and Government: The Past and Future of Economics.
Ostensibly an attempt to answer the question of why mainstream
economics rendered itself so useless in the years immediately before and
after the crisis of 2008, it is really an attempt to retell the history
of the economic discipline through a consideration of the two
things—money and government—that most economists least like to talk
about.
Richard Saker/Contour by Getty Images Robert Skidelsky, London, 2013Skidelsky
is well positioned to tell this story. He embodies a uniquely English
type: the gentle maverick, so firmly ensconced in the establishment that
it never occurs to him that he might not be able to say exactly what he
thinks, and whose views are tolerated by the rest of the establishment
precisely for that reason. Born in Manchuria, trained at Oxford,
professor of political economy at Warwick, Skidelsky is best known as
the author of the definitive, three-volume biography of John Maynard
Keynes, and has for the last three decades sat in the House of Lords as
Baron of Tilton, affiliated at different times with a variety of
political parties, and sometimes none at all. During the early Blair
years, he was a Conservative, and even served as opposition spokesman on
economic matters in the upper chamber; currently he’s a cross-bench
independent, broadly aligned with left Labour. In other words, he
follows his own flag. Usually, it’s an interesting flag. Over the last
several years, Skidelsky has been taking advantage of his position in
the world’s most elite legislative body to hold a series of high-level
seminars on the reformation of the economic discipline; this book is, in
a sense, the first major product of these endeavors.
What it
reveals is an endless war between two broad theoretical perspectives in
which the same side always seems to win—for reasons that rarely have
anything to do with either theoretical sophistication or greater
predictive power. The crux of the argument always seems to turn on the
nature of money. Is money best conceived of as a physical commodity, a
precious substance used to facilitate exchange, or is it better to see
money primarily as a credit, a bookkeeping method or circulating IOU—in
any case, a social arrangement? This is an argument that has been going
on in some form for thousands of years. What we call “money” is always a
mixture of both, and, as I myself noted in Debt (2011), the
center of gravity between the two tends to shift back and forth over
time. In the Middle Ages everyday transactions across Eurasia were
typically conducted by means of credit, and money was assumed to be an
abstraction. It was the rise of global European empires in the sixteenth
and seventeenth centuries, and the corresponding flood of gold and
silver looted from the Americas, that really shifted perceptions.
Historically, the feeling that bullion actually is money tends to
mark periods of generalized violence, mass slavery, and predatory
standing armies—which for most of the world was precisely how the
Spanish, Portuguese, Dutch, French, and British empires were
experienced. One important theoretical innovation that these new
bullion-based theories of money allowed was, as Skidelsky notes, what
has come to be called the quantity theory of money (usually referred to
in textbooks—since economists take endless delight in abbreviations—as QTM).
The QTM
argument was first put forward by a French lawyer named Jean Bodin,
during a debate over the cause of the sharp, destablizing price
inflation that immediately followed the Iberian conquest of the
Americas. Bodin argued that the inflation was a simple matter of supply
and demand: the enormous influx of gold and silver from the Spanish
colonies was cheapening the value of money in Europe. The basic
principle would no doubt have seemed a matter of common sense to anyone
with experience of commerce at the time, but it turns out to have been
based on a series of false assumptions. For one thing, most of the gold
and silver extracted from Mexico and Peru did not end up in Europe at
all, and certainly wasn’t coined into money. Most of it was transported
directly to China and India (to buy spices, silks, calicoes, and other
“oriental luxuries”), and insofar as it had inflationary effects back
home, it was on the basis of speculative bonds of one sort or another.
This almost always turns out to be true when QTM is applied: it seems self-evident, but only if you leave most of the critical factors out.
In
the case of the sixteenth-century price inflation, for instance, once
one takes account of credit, hoarding, and speculation—not to mention
increased rates of economic activity, investment in new technology, and
wage levels (which, in turn, have a lot to do with the relative power of
workers and employers, creditors and debtors)—it becomes impossible to
say for certain which is the deciding factor: whether the money supply
drives prices, or prices drive the money supply. Technically, this comes
down to a choice between what are called exogenous and endogenous
theories of money. Should money be treated as an outside factor, like
all those Spanish dubloons supposedly sweeping into Antwerp, Dublin, and
Genoa in the days of Philip II, or should it be imagined primarily as a
product of economic activity itself, mined, minted, and put into
circulation, or more often, created as credit instruments such as loans,
in order to meet a demand—which would, of course, mean that the roots
of inflation lie elsewhere?
To put it bluntly: QTM is
obviously wrong. Doubling the amount of gold in a country will have no
effect on the price of cheese if you give all the gold to rich people
and they just bury it in their yards, or use it to make gold-plated
submarines (this is, incidentally, why quantitative easing, the strategy
of buying long-term government bonds to put money into circulation, did
not work either). What actually matters is spending.
Nonetheless, from Bodin’s time to the present, almost every time there was a major policy debate, the QTM
advocates won. In England, the pattern was set in 1696, just after the
creation of the Bank of England, with an argument over wartime inflation
between Treasury Secretary William Lowndes, Sir Isaac Newton (then
warden of the mint), and the philosopher John Locke. Newton had agreed
with the Treasury that silver coins had to be officially devalued to
prevent a deflationary collapse; Locke took an extreme monetarist
position, arguing that the government should be limited to guaranteeing
the value of property (including coins) and that tinkering would confuse
investors and defraud creditors. Locke won. The result was deflationary
collapse.A sharp tightening of the money supply created an abrupt
economic contraction that threw hundreds of thousands out of work and
created mass penury, riots, and hunger. The government quickly moved to
moderate the policy (first by allowing banks to monetize government war
debts in the form of bank notes, and eventually by moving off the silver
standard entirely), but in its official rhetoric, Locke’s
small-government, pro-creditor, hard-money ideology became the grounds
of all further political debate.
According to Skidelsky, the
pattern was to repeat itself again and again, in 1797, the 1840s, the
1890s, and, ultimately, the late 1970s and early 1980s, with Thatcher
and Reagan’s (in each case brief) adoption of monetarism. Always we see
the same sequence of events:
(1) The government adopts hard-money policies as a matter of principle.
(2) Disaster ensues.
(3) The government quietly abandons hard-money policies.
(4) The economy recovers.
(5) Hard-money philosophy nonetheless becomes, or is reinforced as, simple universal common sense.
How
was it possible to justify such a remarkable string of failures? Here a
lot of the blame, according to Skidelsky, can be laid at the feet of
the Scottish philosopher David Hume. An early advocate of QTM,
Hume was also the first to introduce the notion that short-term
shocks—such as Locke produced—would create long-term benefits if they
had the effect of unleashing the self-regulating powers of the market:
Ever
since Hume, economists have distinguished between the short-run and the
long-run effects of economic change, including the effects of policy
interventions. The distinction has served to protect the theory of
equilibrium, by enabling it to be stated in a form which took some
account of reality. In economics, the short-run now typically stands for
the period during which a market (or an economy of markets) temporarily
deviates from its long-term equilibrium position under the impact of
some “shock,” like a pendulum temporarily dislodged from a position of
rest. This way of thinking suggests that governments should leave it to
markets to discover their natural equilibrium positions. Government
interventions to “correct” deviations will only add extra layers of
delusion to the original one.
There is a logical
flaw to any such theory: there’s no possible way to disprove it. The
premise that markets will always right themselves in the end can only be
tested if one has a commonly agreed definition of when the “end” is;
but for economists, that definition turns out to be “however long it
takes to reach a point where I can say the economy has returned to
equilibrium.” (In the same way, statements like “the barbarians always
win in the end” or “truth always prevails” cannot be proved wrong, since
in practice they just mean “whenever barbarians win, or truth prevails,
I shall declare the story over.”)
At this point, all the pieces
were in place: tight-money policies (which benefited creditors and the
wealthy) could be justified as “harsh medicine” to clear up
price-signals so the market could return to a healthy state of long-run
balance. In describing how all this came about, Skidelsky is providing
us with a worthy extension of a history Karl Polanyi first began to map
out in the 1940s: the story of how supposedly self-regulating national
markets were the product of careful social engineering. Part of that
involved creating government policies self-consciously designed to
inspire resentment of “big government.” Skidelsky writes:
A
crucial innovation was income tax, first levied in 1814, and renewed by
[Prime Minister Robert] Peel in 1842. By 1911–14, this had become the
principal source of government revenue. Income tax had the double
benefit of giving the British state a secure revenue base, and aligning
voters’ interests with cheap government, since only direct taxpayers had
the vote…. “Fiscal probity,” under Gladstone, “became the new
morality.”
In fact, there’s absolutely no reason a
modern state should fund itself primarily by appropriating a proportion
of each citizen’s earnings. There are plenty of other ways to go about
it. Many—such as land, wealth, commercial, or consumer taxes (any of
which can be made more or less progressive)—are considerably more
efficient, since creating a bureaucratic apparatus capable of monitoring
citizens’ personal affairs to the degree required by an income tax
system is itself enormously expensive. But this misses the real point:
income tax is supposed to be intrusive and exasperating. It is meant to
feel at least a little bit unfair. Like so much of classical liberalism
(and contemporary neoliberalism), it is an ingenious political sleight
of hand—an expansion of the bureaucratic state that also allows its
leaders to pretend to advocate for small government.
The
one major exception to this pattern was the mid-twentieth century, what
has come to be remembered as the Keynesian age. It was a period in
which those running capitalist democracies, spooked by the Russian
Revolution and the prospect of the mass rebellion of their own working
classes, allowed unprecedented levels of redistribution—which, in turn,
led to the most generalized material prosperity in human history. The
story of the Keynesian revolution of the 1930s, and the neoclassical
counterrevolution of the 1970s, has been told innumerable times, but
Skidelsky gives the reader a fresh sense of the underlying conflict.
Christopher Anderson/Magnum Photos - Wall Street, 2008Keynes
himself was staunchly anti-Communist, but largely because he felt that
capitalism was more likely to drive rapid technological advance that
would largely eliminate the need for material labor. He wished for full
employment not because he thought work was good, but because he
ultimately wished to do away with work, envisioning a society in which
technology would render human labor obsolete. In other words, he assumed
that the ground was always shifting under the analysts’ feet; the
object of any social science was inherently unstable. Max Weber, for
similar reasons, argued that it would never be possible for social
scientists to come up with anything remotely like the laws of physics,
because by the time they had come anywhere near to gathering enough
information, society itself, and what analysts felt was important to
know about it, would have changed so much that the information would be
irrelevant. Keynes’s opponents, on the other hand, were determined to
root their arguments in just such universal principles.
It’s
difficult for outsiders to see what was really at stake here, because
the argument has come to be recounted as a technical dispute between the
roles of micro- and macroeconomics. Keynesians insisted that the former
is appropriate to studying the behavior of individual households or
firms, trying to optimize their advantage in the marketplace, but that
as soon as one begins to look at national economies, one is moving to an
entirely different level of complexity, where different sorts of laws
apply. Just as it is impossible to understand the mating habits of an
aardvark by analyzing all the chemical reactions in their cells, so
patterns of trade, investment, or the fluctuations of interest or
employment rates were not simply the aggregate of all the
microtransactions that seemed to make them up. The patterns had, as
philosophers of science would put it, “emergent properties.” Obviously,
it was necessary to understand the micro level (just as it was necessary
to understand the chemicals that made up the aardvark) to have any
chance of understand the macro, but that was not, in itself, enough.
The counterrevolutionaries, starting with Keynes’s old rival Friedrich Hayek at the LSE
and the various luminaries who joined him in the Mont Pelerin Society,
took aim directly at this notion that national economies are anything
more than the sum of their parts. Politically, Skidelsky notes, this was
due to a hostility to the very idea of statecraft (and, in a broader
sense, of any collective good). National economies could indeed be
reduced to the aggregate effect of millions of individual decisions,
and, therefore, every element of macroeconomics had to be systematically
“micro-founded.”
One reason this was such a radical position was
that it was taken at exactly the same moment that microeconomics itself
was completing a profound transformation—one that had begun with the
marginal revolution of the late nineteenth century—from a technique for
understanding how those operating on the market make decisions to a
general philosophy of human life. It was able to do so, remarkably
enough, by proposing a series of assumptions that even economists
themselves were happy to admit were not really true: let us posit, they
said, purely rational actors motivated exclusively by self-interest, who
know exactly what they want and never change their minds, and have
complete access to all relevant pricing information. This allowed them
to make precise, predictive equations of exactly how individuals should
be expected to act.
Surely there’s nothing wrong with creating
simplified models. Arguably, this is how any science of human affairs
has to proceed. But an empirical science then goes on to test those
models against what people actually do, and adjust them accordingly.
This is precisely what economists did not do. Instead, they
discovered that, if one encased those models in mathematical formulae
completely impenetrable to the noninitiate, it would be possible to
create a universe in which those premises could never be refuted. (“All
actors are engaged in the maximization of utility. What is utility?
Whatever it is that an actor appears to be maximizing.”) The
mathematical equations allowed economists to plausibly claim theirs was
the only branch of social theory that had advanced to anything like a
predictive science (even if most of their successful predictions were of
the behavior of people who had themselves been trained in economic
theory).
This allowed Homo economicus to invade the rest of
the academy, so that by the 1950s and 1960s almost every scholarly
discipline in the business of preparing young people for positions of
power (political science, international relations, etc.) had adopted
some variant of “rational choice theory” culled, ultimately, from
microeconomics. By the 1980s and 1990s, it had reached a point where
even the heads of art foundations or charitable organizations would not
be considered fully qualified if they were not at least broadly familiar
with a “science” of human affairs that started from the assumption that
humans were fundamentally selfish and greedy.
These, then, were
the “microfoundations” to which the neoclassical reformers demanded
macroeconomics be returned. Here they were able to take advantage of
certain undeniable weaknesses in Keynesian formulations, above all its
inability to explain 1970s stagflation, to brush away the remaining
Keynesian superstructure and return to the same hard-money,
small-government policies that had been dominant in the nineteenth
century. The familiar pattern ensued. Monetarism didn’t work; in the UK
and then the US, such policies were quickly abandoned. But
ideologically, the intervention was so effective that even when “new
Keynesians” like Joseph Stiglitz or Paul Krugman returned to dominate
the argument about macroeconomics, they still felt obliged to maintain
the new microfoundations.
The problem, as Skidelsky emphasizes, is
that if your initial assumptions are absurd, multiplying them a
thousandfold will hardly make them less so. Or, as he puts it, rather
less gently, “lunatic premises lead to mad conclusions”:
The efficient market hypothesis (EMH),
made popular by Eugene Fama…is the application of rational expectations
to financial markets. The rational expectations hypothesis (REH)
says that agents optimally utilize all available information about the
economy and policy instantly to adjust their expectations….
Thus,
in the words of Fama,…“In an efficient market, competition among the
many intelligent participants leads to a situation where…the actual
price of a security will be a good estimate of its intrinsic value.” [Skidelsky’s italics]
In
other words, we were obliged to pretend that markets could not, by
definition, be wrong—if in the 1980s the land on which the Imperial
compound in Tokyo was built, for example, was valued higher than that of
all the land in New York City, then that would have to be because that
was what it was actually worth. If there are deviations, they are purely
random, “stochastic” and therefore unpredictable, temporary, and,
ultimately, insignificant. In any case, rational actors will quickly
step in to sweep up any undervalued stocks. Skidelsky drily remarks:
There
is a paradox here. On the one hand, the theory says that there is no
point in trying to profit from speculation, because shares are always
correctly priced and their movements cannot be predicted. But on the
other hand, if investors did not try to profit, the market would not be
efficient because there would be no self-correcting mechanism….
Secondly, if shares are always correctly priced, bubbles and crises cannot be generated by the market….
This
attitude leached into policy: “government officials, starting with
[Federal Reserve Chairman] Alan Greenspan, were unwilling to burst the
bubble precisely because they were unwilling to even judge that it was a bubble.” The EMH made the identification of bubbles impossible because it ruled them out a priori.
If there is an answer to the queen’s famous question of why no one saw the crash coming, this would be it.
At
this point, we have come full circle. After such a catastrophic
embarrassment, orthodox economists fell back on their strong
suit—academic politics and institutional power. In the UK, one of the
first moves of the new Conservative-Liberal Democratic Coalition in 2010
was to reform the higher education system by tripling tuition and
instituting an American-style regime of student loans. Common sense
might have suggested that if the education system was performing
successfully (for all its foibles, the British university system was
considered one of the best in the world), while the financial system was
operating so badly that it had nearly destroyed the global economy, the
sensible thing might be to reform the financial system to be a bit more
like the educational system, rather than the other way around. An
aggressive effort to do the opposite could only be an ideological move.
It was a full-on assault on the very idea that knowledge could be
anything other than an economic good.
Similar moves were made to solidify control over the institutional structure. The BBC,
a once proudly independent body, under the Tories has increasingly come
to resemble a state broadcasting network, their political commentators
often reciting almost verbatim the latest talking points of the ruling
party—which, at least economically, were premised on the very theories
that had just been discredited. Political debate simply assumed that the
usual “harsh medicine” and Gladstonian “fiscal probity” were the only
solution; at the same time, the Bank of England began printing money
like mad and, effectively, handing it out to the one percent in an
unsuccessful attempt to kick-start inflation. The practical results
were, to put it mildly, uninspiring. Even at the height of the eventual
recovery, in the fifth-richest country in the world, something like one
British citizen in twelve experienced hunger, up to and including going
entire days without food. If an “economy” is to be defined as the means
by which a human population provides itself with its material needs, the
British economy is increasingly dysfunctional. Frenetic efforts on the
part of the British political class to change the subject (Brexit) can
hardly go on forever. Eventually, real issues will have to be addressed.
Economic
theory as it exists increasingly resembles a shed full of broken tools.
This is not to say there are no useful insights here, but fundamentally
the existing discipline is designed to solve another century’s
problems. The problem of how to determine the optimal distribution of
work and resources to create high levels of economic growth is simply
not the same problem we are now facing: i.e., how to deal with
increasing technological productivity, decreasing real demand for labor,
and the effective management of care work, without also destroying the
Earth. This demands a different science. The “microfoundations” of
current economics are precisely what is standing in the way of this. Any
new, viable science will either have to draw on the accumulated
knowledge of feminism, behavioral economics, psychology, and even
anthropology to come up with theories based on how people actually
behave, or once again embrace the notion of emergent levels of
complexity—or, most likely, both.
Intellectually, this won’t be
easy. Politically, it will be even more difficult. Breaking through
neoclassical economics’ lock on major institutions, and its
near-theological hold over the media—not to mention all the subtle ways
it has come to define our conceptions of human motivations and the
horizons of human possibility—is a daunting prospect. Presumably, some
kind of shock would be required. What might it take? Another 2008-style
collapse? Some radical political shift in a major world government? A
global youth rebellion? However it will come about, books like this—and
quite possibly this book—will play a crucial part.
