Foul-Weather Friends

Radical critique from an unexpected source — the head of currency trading at a major Wall Street firm considers global capital markets.

In response to the end of the credit cycle, policy makers and central bankers in the high-income countries have exponentially increased their presence in the capital markets. Debt issued by governments has soared and central banks are pursuing unorthodox policies — the aim of which varies from country to country.

The purpose of quantitative easing in the US, especially the latest reiteration, is to accelerate employment growth. The European Central Bank’s Outright Market Transactions is to ensure a proper transmission of its monetary policy to countries that agree to EU/IMF conditionality and have access to the capital markets. Japan’s asset purchase program, through which it buys not only government bonds, but also ETFs, REITS and corporate bonds, is to fight deflation.

Initially, the Swiss National Bank bought foreign bonds as a way to arrest the franc’s appreciation that was fueling deflationary forces in Switzerland. When this failed, it moved to formally cap the franc. The SNB now buys sufficient foreign currencies to defend it. The Bank of England’s gilt purchase program seemed aimed at strengthening the economy, though it is much less concerned about the labor market than is the Federal Reserve.

Some economists call this “financial repression.” It occurs, they say, whenever a sovereign interferes with free market activity and the pricing of debt or currency. Of course, such a broad definition means that financial repression has been around forever. For example, it is akin to shaving some precious metal from coins in ancient Rome.

By artificially lowering the cost of debt below what would prevail in a free market, quantitative easing has been called a “stealthy default” by PIMCO, one of the largest bond investors in the world. It also suggests that it is a sneaky form of taxation: “a gentlemanly way for modern countries with fiat currencies to stiff creditors while still ostensibly paying interest and principal in full.”

There are two problems with this narrative despite its widespread acceptance. First, the financial repression thesis (FRT) imagines a state of nature in which the market exists, but the state does not. This view implies that the market is natural and the state artificial. But if this is the case, any action by the state in the financial markets falls under the expansive definition of financial repression.

The factors of production — land, labor and capital — were not always regarded as commodities that can be traded and bought in the market place. Karl Polanyi traces this development in his classic The Great Transformation: The Political and Economic Origins of Our Time. The point is that modernity was co-created by the rise of the modern state and the market economy. The two were inseparable.

A strong state was needed to overturn the reciprocal rights and responsibilities that limited the scope of the markets in traditional societies — think feudalism, for example. Each of the factors of production sought to escape the omnipresent market by organizing. Individual capitalists organized through various forms, like pools, trusts, cartels, and corporations. Labor organized in industrial and trade unions. Farmers organized in cooperatives, collectives, and political parties.

The kind of capitalism that Charles Dickens chronicled, and Fredrich Engels documented, required the visible hand of the state to ameliorate some of the harsher consequences of the market. None less than Bismark, Churchill, Theodore Roosevelt — heading up the Republican wing of the family, a generation before FDR — recognized this.

The second problem with the FRT grows out of the first, but is considerably less abstract. FRT misconstrues the conflict that is at the center of its narrative. The state, it is claimed, seeks to siphon off some of the funds that in a free-market would go to investors and savers. These funds go to the sovereign, but ultimately, FRT sees the objective of financial repression as redistribution.

FRT emphasizes only one aspect of unconventional monetary policies: interest rates. Yet, the conflict between savers and debtors is multifaceted. To truly assess the state of financial repression, a broader inquiry is required.

Let’s concede, for the sake of the argument, that the Federal Reserve’s long-term asset purchases did drive down US yields, depriving savers of interest income.

There are two income streams that flow to capital and accrue to savers, interest rates and profits. FRT holds that savers are being “repressed” by the Federal Reserve pushing interest rates lower than they would otherwise be. But savers are not only coupon clippers. They are investors too. They were rewarded by holding bonds that increased in price.

Moreover, riskier assets like stocks have done better under these policies, hence rewarding savers who invest in these asset classes as well.  Indeed, since the Fed’s long term asset purchases began shortly after the demise of Lehman, the S&P 500 has risen by almost 75%.

In addition, the US reduced the tax on capital gains and dividend income. This clearly favors the owners of capital, which, of course, are savers by definition. Many savers are also home owners. The government and Federal Reserve’s “encroachment” into the markets have directly and indirectly supported the real estate market and home prices. This tends not to be part of discussions of financial repression, but it ought to be.

FRT accuses the government of “repressing” the owners of capital. Yet, wealth and income have become increasingly more concentrated in the US since the late 1960s or early 1970s. It has trended through Republican and Democrat Administrations and has continued unabated through the booms and busts of business and credit cycles.

In recent decades, the productivity gains generated by both labor and capital have gone disproportionately to the owners of capital. Wages in the US have not kept pace with gains in productivity. The share of national income accounted for by profits has continued to grow, even during the post-Lehman period, when FRT gained greater currency.

Actions by the government and the Federal Reserve may moderate the pace of accumulation in one area or another from time to time, but also accelerate it in other areas.

In fact, the very success of the owners of capital in securing the elephant’s share productivity gains and ensuring low effective taxes, lies at the very heart of the credit crisis.

Briefly, even if crudely, the decoupling of men’s wages from productivity made both possible and necessary wider participation of women in the work force. This too proved insufficient to procure the “American Dream” — a car, a home, a decent education.

Transfer payments also proved insufficient. Credit filled the gap and bought social peace, which meant no fighting over distribution of the social pie. The end of the credit cycle threatened this arrangement. The extraordinary government action in response to the crisis was largely intended to restart this circuit of capital. The large and persistent gap between deposits and loans at large financial institutions indicates that the transmission mechanism is still broken.

At those rare times when the system that favors the owners of capital is at risk, officials can moderate the pace at which capital is accumulated.  This is why it is important to recognize that the growth of the state is, historically speaking, as much, if not more, a conservative project as it is a progressive one.

FRT has a close relative: the Central Bank Independence Thesis (CBIT). It focuses on the action of central banks rather than governments. The main argument is that the unconventional policies of central banks carry significant political repercussions, so it should not be a job for independent technocrats. Because there are “winners” and “losers” from the unconventional monetary policies, governments will increasingly have little choice but to encroach upon the independence of central banks to shape the outcomes.

Central bank independence was never what it was cracked up to be. During “normal” times, central banks protected the interests of the owners of capital. Paul Volcker is often cited as the epitome of the independent central banker, but surely his tight monetary policy, justified in terms of some technocratic money supply target created winners and losers. The owners of capital were among the winners, while those who did not own capital were losers (through such things as higher unemployment and downward pressure on real wages).

Moreover, most central banks have only one goal: price stability. Some central banks are given an inflation target, like the Bank of England, which incidentally only recently was granted what many would call independence. Other central banks are given a goal of price stability, but chose how precisely to define it.

The definition of price stability is itself not a value-free technocratic decision. Some central banks focus on core inflation and others on headline inflation. If, for example, the ECB focused on core inflation rather than headline inflation, it arguably would not have hiked rates in July 2008 as the euro area economy was already contracting.

In addition, many central banks have defined price stability as around 2% annual inflation. Yet there is no material difference between 2% inflation and 2.5% inflation or even 3% inflation.

This argument can be pushed further. The fact that most central banks have price stability as their sole mandate is a reflection of a certain set of values and, dare one say, an ideological bias. Only the US Federal Reserve (and perhaps soon the Bank of Japan), has a full employment goal. While inflation hurts the owners of capital, it eases the burden on those who don’t own capital. From a purely technocratic and neutral point of view, it is not clear why monetary policy should not target nominal GDP or asset prices.

The setting of monetary policy was never simply a technocratic exercise as the CBIT pretends. There were always those interests that benefited and those who did less well. Few cried of a loss of central bank independence, for example, when the Bundesbank would threaten tighter monetary policy in reaction to unions seeking a sharp increase in wages.

It is apparently acceptable for the Federal Reserve to use monetary policy to aid the government’s war efforts against foreign enemies, but not against the scourge of high unemployment or other domestic policy goals.

The US Treasury Secretary was a member of the Federal Reserve Open Market Committee (FOMC) from FDR’s re-organization of the Fed until the early 1950s. Even before the new Abe government in Japan, it was not unusual for an official from the Finance Ministry to sit in on Bank of Japan meetings.

CBIT makes a fetish out of independence. In modern parliamentary democracies, there is no room for such a concentration of power that is not part of a system of checks and balances. From whom should the central banks be independent? Usually the answer is from short-sighted politicians who may be tempted to pump the economy for some electoral gain. Yet these are the same politicians we trust with national security and the power of the purse (i.e., tax and spend) and the very politicians that appoint the central bank boards anyway.

It is not simply in the inflation target where the ideological and political bias of the central bank is laid bare. The mere act of treating the central bank like no other institution in a representative democracy is itself laden with political values that favor some over others.

The Financial Repression Thesis and the related Central Bank Independence Thesis recognize the conflictual nature of society. The interests of the owners of capital differ from the interests of those who do not own capital. An important role of the government and the central banks is to preserve and sustain that conflict.

The purported neutrality of governments and central banks is in fact a self-serving myth. They both seek to preserve a privileged place for the owners of capital (as a group and this may mean sacrificing the interests of any single owner of capital). The lower rate of interest that may be accruing to the owners of capital is not repressive. The loss of interest income is offset by the rise of corporate profits, equity (and other financial asset prices), and real estate prices.

The financial crisis grew out of the very success of the owners of capital in securing productivity gains and extracting profits at levels well beyond which can be used for future profitable investment. This not only created the conditions for unstable and unsustainable debt-financed-consumption, but also required an elaborate and expensive financial super-structure and complex products to absorb the surpluses.

Governments and central banks have overseen an incredible concentration of wealth and income over the last few decades. Cries of financial repression are heard only when they seek to moderate part of the pace of capital accumulation. There was no outcry from Wall Street when governments broke labor unions (Thatcher and the miners and Reagan and the air traffic controllers).

The concentration of wealth and income has become so great that it threatens social stability. A more balanced distribution of productivity gains can serve to minimize the chance of financial crises. This is the proper aim of a democratic and representative government. A stable society requires that the levers of policy — security, fiscal and monetary — be accountable to the people. It is the absence of that accountability, not low interest rates, that is the true repression.