Valdai Club

Practically the first response of Western authorities, when they finally acknowledged the gravity of the threat posed by the novel Coronavirus amid the Stock market collapse and the World Health Organization proclamation of a pandemic, was monetary. Led by the United States Federal Reserve, which promised to use its full range of tools to support the financial market, Western central bankers lowered their already low interest rates to zero, announced further trillions of asset purchases. This had been the main response of public authorities to crises for decades and, as far as large wealth holders (rather than ordinary citizens) were concerned, it had worked. Each time the bubbles their speculative activities blew up burst, they were bailed out, while the millions who lost jobs, homes, pensions and other critical life supports remained without succour.

This time, however, it is clearly not enough. The present crisis is not, fundamentally, a financial crisis but an economic crisis. It originates in the productive economy, not the financial sector, Main Street, not Wall Street.  Decades of neoliberal prioritising of the financial over the productive economy were already coming to a head when the pandemic hit. It has only accelerated advance toward a reckoning that was becoming long overdue after more than four decades of neoliberal policies inaugurated by Thatcher and Reagan. 

Neoliberalism was the alleged solution to the Long Downturn that the world economy entered in the 1970s. Its claim was that the ‘dead hand of the state’ had been dampening economic activity. Removing it would restore capitalism’s ‘animal spirits’, freeing it to start investing and creating jobs. In reality, the major underlying problem was lack of adequate demand in relation to accumulated (and accumulating) capacity and the neoliberal solution, with its downward pressure on state expenditure, wages and productive investment, only exacerbated it. That problem could only be addressed with vigorous fiscal policy, that is, direct government action to increase economic activity, employment and incomes, income equality and to pursue other social priorities. That however, was precisely the option that was eschewed. It went against the grain of neoliberalism. No wonder that world and Western growth rates were lower in the past four neoliberal decades than in the much-derided statist and dirigiste three decades after the Second World War. 

Instead of the fiscal policy solution, asthe problems of neoliberalism accumulated, public authorities left matters to central banks and their monetary policies. In recent decades, and particularly the past one, Central bankers and their anointed pundits have kept the public mesmerized with their monetary conjuring tricks. They pull ingenious, even bizarre, monetary policy rabbits out of their hats—ever lower interests rates, negative interest rates, quantitative easing (QE), central bank policy guidance and what not—creating the impression that they are straining every grey cell to save the world economy. However, it is all a classic red herring: John Maynard Keynes long-ago warned that a time would come when monetary policy alone would not “be sufficient by itself to determine an optimum rate of investment”, and thus an acceptable rate of growth. Its effectiveness would be tantamount to “pushing on a string”. As far as the productive economy was concerned, this has long been the case. And now that the crisis originates in the productive economy, which was already showing signs that it had taken all the abuse as it can well before the pandemic hit, the pretence that monetary policy will solve economic problems can no longer be sustained.

The Wrongs of Monetary Policy

While the focus on monetary policy has diverted public attention from much needed fiscal activism, it has wreaked great havoc of its own. Rather than reviving the productive economy, neoliberalism only benefitted the financial sector, with its deregulatory thrust and the adverse demand conditions it created, which sent funds into asset markets rather than into productive investment. The neoliberal era has been characterised by the increasing frequency with which financial asset bubbles have appeared, and then burst, causing economic crises in their wake. However, rather than curbing such speculative activity and regulating the financial sector so as to re-orient it to productive investment, financial regulators have only encouraged the speculative orientation and this has even been justified as a growth strategy – with the ‘wealth effects’ of financial bubbles expanding markets – by prominent economists. 

We can date precisely when this policy orientation became clear. The 1987 stock market crash was the first major financial crisis of the neoliberal era and the newly appointed Federal Reserve Chairman, Alan Greenspan, responded with his infamous Greenspan Put, essentially restoring vanishing liquidity—replenishing the punch bowl—so that the speculative party could go on. Since then the Federal Reserve and its sister Western central banks have responded to financial crises with further injections of liquidity, both by lowering interest rates and by the more direct means of purchasing less liquid or illiquid assets for good cash, otherwise known as quantitative easing.

Such monetary policy has been justified as necessary to restore investment, employment and growth but the only thing it restores is the ability of the financial sector to continue its unproductive, inequality exacerbating, speculation. The bursting of resulting series of asset bubbles – the 1987 stock market crash, the various financial crises of the early and mid-1990s culminating in the East Asian Financial Crisis of 1997-8, the dot-com crash of 2000 and the 2008 crisis – have only increased the fortunes of the 1 percent and to a lesser extent, the 10 percent, and caused great economic distress among the 90 percent.

2008 did Change Some Things

While monetary policy has continued replenishing the punch bowl, the party has been distinctly less merry, particularly after 2008. In its wake, two major changes occurred. On the one hand, the international overextension of banks in the run up to the 2008 crisis led to a re-examination of investment strategies of financial sectors, particularly in Europe. After all, it was not the ‘Asian Savings glut’ channelled into the purchase of US treasuries, but the massive investment of the newly deregulated European financial sector that had played the critical role in inflating the US housing and credit bubbles. On the other hand, since the excesses of the financial sector could no longer be denied, regulation became necessary. Though the financial sector avoided many of its dangers, including greater scrutiny, transparency and accountability, regulation was not without effect. In particular, it imposed higher reserve requirements, restraining, if not eliminating, the ability of banks to speculate. Given just how much monetary throw-weight is needed to make money in financial markets today—the sheer scale of money seeking returns cannot but thin margins—even this relatively weak imposition has affected financial sector profits.

No wonder then that international capital flows, which fell steeply in 2008 and then recovered, still remain 65 percent below their pre-2008 peak despite central bank generosity. Even so, the past decade has witnessed a considerable stock market bubble and it has now burst. With its massive monetary policy response, the Federal Reserve has pretty well used up all the ammunition it had carefully gathered since 2015, when it started raising interest rates so that it could lower them in the next inevitable crisis. Interest rates are now at or near zero. Negative interest rates are not really an option. Even the more adventurous Europeans have not ventured beyond -o.5 percent and the Federal Reserve has hitherto been unwilling to go into negative territory at all. The markets have since recovered somewhat but it is unlikely they can sustain that recovery. 

The Problem this Time

No matter how high asset valuations go in any speculative frenzy, no matter how much the Federal Reserve encourages them, ultimately they are governed by the gravity exerted by the productive economy, its needs and wants. The dot-com bubble had to burst given the valuelessness of so many of its ‘asset lite’ stocks. The housing and credit bubbles burst in 2008 when interest rates had to be raised to preserve the US dollar’s value amid rising commodity prices, leading to slowing house price rises and more and more ‘underwater mortgages’ worth more than the prices of the houses they were hypothecated to. Today the problem for the stock market may have been triggered by the pandemic, but touches on deeper underlying problems. They have just got considerably worse and are unlikely to go away anytime soon. 

As asset markets, which finance speculation in the value of already produced assets, grew in size over the decades, they far outstripped any reasonable proportion with productive activity—investment in the production of new goods and services (what some call the ‘real’ economy)—even as they relied on it. In the present crisis, the pertinent form of reliance is this: Banks and financial institutions accept deposits of productive corporations as their highest quality funding. Under the impact of supply and demand shocks, however, the productive corporations have been drawing down these deposits and even borrowing. Moreover, all big corporations are doing it all together at once.

While this has not triggered an immediate banking crisis, trouble may not be far off: as a Financial Times columnist recently noted, the very Dodd-Frank and other post-2008 regulatory tightening that has made banks more resilient requires them to have a minimal level of such quality deposits. “Losing these deposits so quickly threatens the liquidity profile and regulatory compliance of banks themselves. And that is before we start to see the spike in corporate downgrades and defaults that will create even more funding pressure.”

The Fed’s offer of liquidity no longer works because what the economy now needs is some way to create demand, both consumer and investment demand, to restore and expand production, and to re-orient it towards more equal, sustainable and meaningful directions than the consumerism on stilts that came with neoliberalism. This can only be the work of governments. 

This poses a problem for capitalism. On the one hand, without it, a generalised financial and economic crisis far deeper than the temporary dip on production and consumption that the pandemic alone would cause is not far away. On the other hand, if the government steps in and actually does what is needed, it will require the state to replace private capital in determining the pace and pattern of growth to such an extent as to put a question mark over the future of capitalism.