It's time to identify and evaluate the basic assumptions and strategy of President Obama's recovery plan. Such an assessment suggests that if present economic strategy continues, in the end the "new normal" will be a chronically indebted low-wage American worker. Let's look first at Obama's fundamental justification for bailing out the financial elite rather than the working majority, and then at the economic situation of the median worker, who will bear the burden of the consequences of this policy. Along the way, we will identify a few widespread misconceptions about the workings of the banking system. We'll conclude with a look at the "new normal" promised by the prevailing elite consensus.
Obama's Rationale for the Recovery Program
Many Americans resent that Obama's rescue plan bails out the perps while leaving the rest twisting in the wind. In an April speech at Georgetown University, he addresses this very issue:
"And although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks- 'Where's our bailout?,' they ask -the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth." (The New York Times, April 14, 2009 "Obama Stands Firm on a Sweeping Agenda", by Peter Baker)
Obama's reference to the "multiplier effect" is straight out of Economics 101: a dollar injected into the income stream generates more than a dollar's worth of spending power, because when that dollar is spent it becomes someone else's income. It is then spent again, becoming a new recipient's income and is spent yet again. and then again, and ... Here's an example of Obama's Georgetown scenario, in which banks extend "loans to families and businesses" : a bank lends $5 million to build a factory. Out of this sum, the factory owner pays suppliers for, say, steel and concrete, and pays wages to builders. The suppliers and builders will spend (consume) their new incomes, which thereby creates new purchasing power for the recipients. And on it goes. The same kind of income chain is created when banks lend to "families": household spending becomes income to owners and employees of retail outlets, whose investment (by owners) and consumption (by employees) constitute further expenditures, which in turn... You get the picture.
All this additional spending triggered by the initial injection, Obama claims, "can ultimately lead to a faster pace of economic growth," i.e. an increase in employment-generating investment, growth in wages and spending, increased output and higher profits - in short a resumption of the economic growth that is supposed to have graced the economy from the end of World War II until just a few years ago.
Obama's reasoning contains factual inaccuracies, misconceptions and strategic omissions. Among these is a seriously flawed conception of how the banking system works.
Misconceptions About What Banks Do
School kids are taught that banks lend from their reserves, which consist in John's deposit, which is then lent to Mary. The interest paid to depositor John is less than the interest charged to borrower Mary, and the difference is what constitutes the bank's profit. This is said to be how banks make money. Later on we are told that government infusions of money are added to consumer deposits to make up banks' total reserves. By the time the kids get to college, there is scarce talk of consumer deposits. Now the financial equivalent of Let There Be Light is the decision by the central bank to create money. The Obama administration plans and executes its economic policy within this fictitious framework.
The story hooks you by starting with the truism that banks lend at interest rates greater than the rates paid to depositors. Fine. But what makes the textbook story social-science fiction is the imagined relation between credit money and debt money: first, government creates credit money, which is then distributed as reserves to local banks, which proceed to issue it as debt money to borrowers. This creates a significant source of household spending power. The economic catechisms stipulate that it is the central bank which creates money from nothing, thereby making possible the world of various and sundry banking activities with which we are all more or less familiar.
Except that isn't what happens. The monetary primacy of the central bank was never established by empirical research. It is an axiom of "static equilibrium" theoretical models of how the economy works.
The first economists to actually test the claim that it is the central bank that originates money were late-1970s post-Keynesians, of whom the US economist Basil Moore is credited with establishing that it is simply not the case that increased lending by banks is enabled by their prior accumulation of excess reserves created by government infusions of liquidity.
Money is indeed created from nothing, but it is in fact the lowly banks themselves that initiate the process.
The implications are important for our grasp not only of the terminal flaws in current theory and policy, but also of the only alternatives promising the slightest chance of heading off an emerging era of long-term austerity for working people.
So how exactly do banks work, and why is the answer important?
What Banks Actually Do
More than 10 years after the post-Keynesian revelation, Finn Kydland and Edward Prescott, two Nobel Prize winners at the Federal Reserve Bank of Minneapolis, published "Business Cycles: Real Facts and a Monetary Myth" in the Bank's Spring 1990 Quarterly Review. They found that credit money was created by ordinary banks well before the creation of central bank money. And even before that, less-widely-read experts in the field were telling it like it is.
In a booklet titled "Modern Money Mechanics", released in 1961 by the Public information Center of the Federal Reserve Bank of Chicago, we find:
"[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to borrowers' transaction accounts."
And here is Graham Towers, Governor of the Bank of Canada, 1935-1955:
"Banks create money. That is what they are for. .. [Making] money consists of making an entry in a book . That is all...Each and every time a bank makes a loan, new bank money is created - brand new money."
When a bank extends a loan, it merely credits the borrower's checking account in the amount of the loan. No money was previously paid in to the bank, neither by household depositors, nor by the central bank.
Why Does It Matter?
What is striking is that the ultimate instigators of money creation are the household and the (usually small) business owner. (My focus here is on the consumer, whose spending accounts for 66-73% of GDP.) It is in response to events set in motion by the initial loan request that banks petition the central bank for reserves, to cover losses, defaults and the like. If the consumer is willing and able to spend, (s)he seeks a loan from the bank, and the stream of spending begins. The lower the level of consumption demand, the less the need for infusions from the central bank. We should expect, then, that should the central bank flood banks with liquidity in the face of low consumer demand, these reserves will either be used, say, to further consolidate the industry by buying weaker banks, to pay bank managers obscene bonuses, to goose the stock market to produce a speculative asset rally or to function as a cover for underlying insolvency. These liquidity infusions contribute nothing to their stated aim, which is, in Obama's words, "to lead to a faster pace of economic growth."
Obama chooses his words with care. He tells us that "a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses." "can" Sure it can, but only if consumers / households are perceived by banks as credit worthy and households are in fact inclined to borrow.
But the dire circumstances of households originated well before September 2008. 1973 was the peak postwar year for the median wage, which has been in secular decline for 36 years, even as the costs of health care, child care and education have risen at a quicker pace than inflation. Households have continually tried to adapt to this crunch, by sending more household members into the labor force, by taking on multiple jobs, and finally by leaning more heavily on the credit crutch. This overall circumstance has been dramatically magnified by the current crisis, during which $2 trillion of retirement savings has been lost. Recent surveys find that 70% of workers intend to work during their retirement years. None of this has been taken into account in the recovery plan. As in the textbooks, the consumer is assumed to be unencumbered and ready and able to spend and to incur debt.
In this context Obama's invocation of the multiplier misses the point: "a dollar of capital in a bank can actually result in eight or ten dollars of loans to famiies and businesses." In order for the $1 trillion that the Fed has lavished on banks to produce " a faster pace of economic growth" , unprecedentedly indebted households and businesses would have to take on an additional $8-10 trillion in debt. Indebtedness would become a way of life. More on this below.
An economic profile of the median wage earner paints a more vivid picture of the Obama policy's impact on real people.
The Personal Finances of the Median Wage Earner
Let's look at the US Census Bureau's Consumer Income Report issued in August 2008, immediately before the eruption of the crisis. Calculations from these data will err on the side of optimism. The figures were compiled before a marked decline in the income and employment picture, and the figures for households are less alarming, for obvious reasons, than are the data for individuals.
According to the Report, real median household income is $50,233. Half of the households make more, and half make less. But let's look also at a fatter figure, for households headed by married couples. These have a median income of $72,785.
We'll focus on the household's biggest economic decision, the choice to purchase a home. The median price of a single family home in the first quarter of 2009 was $169,000. It would cost the $50,233 household almost 3.5 times their annual income to buy the median-priced house. The median-priced home would seem to be more affordable for the headed-by-a-married-couple family taking in $72,785 a year. The price/income ratio for this family is 2.35. But not so fast. What do the family's actual monthly expenditures look like?
We'll retain optimistic assumptions. Assume the couple puts down 20% on the new house, and takes a loan of $135,200. The current 30-year fixed mortgage stands at 5.75%, which will cost them $788.99 a month for the loan. Our couple is taking in $6,000.00 a month before taxes, so let's do the tax numbers.
With their employers covering half of their Social Security and Medicare taxes, they are down 7.65% of the $72,000, or $5,508. Uncle Sam's 20% cut chops off another $14,400. Average state and local taxes come to about 3%, so we deduct another $2,160.
Our median couple is now taking in $4,161 a month. Assume they have health insurance, which we'll figure at about $500.00 a month. Car payments and insurance will cost them somewhere between $500.00-$1,000.00, and gas at least $100.00-$200.00. Groceries for a family of 3 or 4 will cost an additional $600.00 a month. The median family uses cell phones, cable and the web, which we'll generously price at $150.00 a month.
With monthly bills in the vicinity of $2,000, they've still not paid their housing costs. These include more than the mortgage payment of $788.99. They're shelling out around $1,700 at a low property tax rate of 1%, roughly $1,000.00 for insurance and about $300.00 a month for utilities.
This leaves the Medians with a disposable income of $872.00 a month. But not really. There are additional costs which are not as easily calculable as the more or less essential ones identified above. Clothes are indispensable. Movies and dining out. Vacations have been considered a fixed cost of good living, but an increasing number are having to scale down or flat out reclassify travel as a discretionary expense. Regular maintenance of the house and car, as well as addressing unexpected emergencies, including of course medical crises, are at least partially foregone by a rising number of regular folks. (Our ardently Republican family physician tells me that she is alarmed by the number of patients who tell her that they must cut back on food in order to pay for prescriptions.) Deductibles, out-of-pocket expenses and prescription drug payments are often sizeable. And there are the perpetually escalating costs of education and child care.
That $872.00 a month is being whittled down to a pittance. And keep in mind that half of the median wage earners are worse off than this; half of that lower half lives below the official poverty line. No wonder the only way so many people have held their finances together is with the glue of credit.
This unenviable position gets worse. There is the ongoing economic crisis, which we are assured by Obama-Bernanke will improve soon, even as cumulative job loss, declining wages, and increasing foreclosures and bankruptcies persist for years. Many of what used to be the highest-paying wage earning jobs with the most generous benefits will disappear, and those remaining will suffer wage reductions of up to 50%, sharp reductions in health benefits and further erosion of the power of virtually impotent labor unions. The "restructuring" of the auto industry is the handwriting on the wall for the wage-earning population (the majority, remember, of the entire population).
It is fantastic in the extreme to imagine, as the Obama team does, that greater working-class indebtedness is any part of a solution to embedded structural problems.
The Paradox at the Heart of the Problem
The living standards of working people have been under assault by Democratic and Republican gravediggers of the NewDeal and the Great Society for 36 years. Global neoliberalism confronts vanishing industrial investment opportunuties in the form of global excess manufacturing capacity, and intensified global competition resulting from the successful reindustrialization of Europe and the emergence of formidable competitors in China, India, Brazil and elsewhere. The response has been to embark upon a worldwide cost-cutting campaign. And of course the costs targeted are labor costs.
A successful campaign against wages and benefits depresses the largest source of the demand for GDP, the consumption of working people. By the canons of any school of economic thought, this is a surefire recipe for depression. What is required to restore the economy to health -even capitalist standards of health- is anathema to capitalism, namely a determined poitical-economic campaign to raise workers' income and benefits dramatically.
Obama and his advisors are insisting that this will be the happy result of the recovery plan. We have seen that this is most unlikely. The prevailing sentiment of the financial elite unwittingly underscores the circular logic undermining the recovery plan. Here is the New York Times's account of the thinking of the typical financial poobah:
"It doesn't matter how much Hank Paulson gives us," said an influential senior official at a big bank that received money from the government, "no one is going to lend a nickel until the economy turns." The official added: "Who are we going to lend money to?" before repeating an old saw about banking: "Only people who don't need it." (Oct. 20, 2008 "One Day Doesn't Make a Trend," by Andrew Ross Sorkin.)
The banks won't lend freely until the economic crisis is ended, but the crisis won't end until the banks lend to people who are broke.
Mass Mobiization Replaces the Keynesian State: Shortening Labor's "Unusually Long Fuse"
The above-described contradiction in the financial system today is unlikely to be addressed by the kind of Keynesian state which forestalled a resumption of the Great Depression after the Second World War. The state is now transparently fashioning policy in the interests of the financial elite, which now designs and often executes policy, as I the case of the bailout. These fellows don't depend on production and employment to make their fortune. They sell not widgets but debt, the most fitting product for a population mired in austerity.
And enduring austerity is the only alternative given the imperatives and interests of the financial plutocracy. The media have been foreshadowing the structural changes that the economy is moving toward. In "Job Losses Hint at Vast Remaking of Economy" (NYT, March 7, 2009, by Peter S. Goodman and Jack Healy) we are told that
"...growing joblessness may reflect a wrenching restructuring of the economy.... In key industries - manufacturing, financial services and retail - layoffs have accelerated so quickly in recent months as to suggest that many companies are abandoning whole areas of business. "These jobs aren't coming back," [said a chief economist at Wachovia] "A lot of production either isn't going to happen at all, or it's going to happen somewhere other than in the United States. There are going to be fewer stores, fewer factories... Firms are making strategic decisions that they don't want to be in their businesses."
The article quotes a Stanford Hoover Institution economist as saying "The decimation of employment in legacy American brands such as General Motors is a trend that's likely to continue. We have to stimulate the economy to create jobs in other areas."
And what might these new jobs be in an America now resigned to ongoing deindustrialization? The Bureau of Labor Statistics released a study in 2006 identifying the occupations projected to add the greatest number of jobs between 2006 and 2016. These are not jobs characteristic of a high-wage, high-productivity economy. They are: - - nursing aids, orderlies and home health aids
- registered nurses
- retail salespersons
- customer service representatives
- food preparation and serving workers
- general office clerks
- personal and home care aides
- postsecondary teachers
- janitors and accounting clerks
Not a widget producer to be found.
In the Georgetown speech Obama alerts us that "We must lay a new foundation for growth and prosperity, where we consume less at home and send more exports abroad." Obama has repeatedly underscored that the main propellants of "new normal" growth will be investment and exports, attended by reduced consumption -necessitated by wage reduction- at home. He is in tune with the neoliberal Economist magazine, which, in expanding on the notion that consumption will play a much diminished role in future US growth, writes "Something else will have to grow more quickly. Ideally that would be exports and investment." (May 6, 2009)
The picture is clear: wage reduction is a strategic imperative if the US is to regain the competitive edge it enjoyed in the boom years 1949-1973. Policymakers are convinced that manufacturing activity is gradually shifting from the US, Europe and Japan to China, India, Brazil and other low-wage countries, so that US companies will be increasingly in competition with firms located in predominantly low-wage countries. US workers will have to make the necessary "adjustments." Obama was quite explicit in an interview on September 18 with the editors of the Pittsburgh Post-Gazette (September 18, 2009).
"Pittsburgh is now having to pay attention to what happens in Beijing and Bangladore and Eastern Europe in ways that in the past it didn't have to pay attention to... The manufacturing base that employed so many people, the decline in that sector of the economy took decades. It didn't start last year, it's been going on for two decades. And reversing that and rebuilding it is going to take two decades as well."
It doesn't get any clearer than that. Remaking American industry in the image of the restructured General Motors and Chrysler will take decades, after which a leaner, meaner America employing workers making poor-country wages will rise from the ashes to regain its status as a great power whose economic prowess will once again match its military predominance.
This is the kind of "recovery" that current policy serves. President Obama promotes, or does little to defeat, policies whose net beneficiaries are financial poobahs, insurance companies, and Big Pharma. It's becoming increasingly clear that only mass politics can address this situation.
A mass movement organized around, e.g. continuously widening, scandalous inequalities not seen since the early 20th century, would resonate with countless Americans.
Mainstream media report mass disaffection with permanent war and transparently elite-driven policy. In "In America, Labor Has an Unusually Long Fuse" Steven Greenhouse (New York Times, April 5, 2009) hits the nail on the head. He contrasts the relative miitancy of European labor, which has in fact made it far more difficult for European capital to impose neoliberal "reforms" on workers there, with the inertia of US workers:
"...[M}ore than a million workers in France demonstrated against layoffs and the government's handling of the economic crisis...French workers took their bosses hostage four times in various labor disputes. When General Motors recently announced huge job cuts worldwide, 15,000 workers demonstrated at the company's German headquarters. But in the United States, where G.M. plans its biggest layoffs, union members have seemed passive in comparison... Unlike their European counterparts, American workers have largely stayed off the streets, even as unemployment soars, and companies cut wages and benefits."
Curiously, Greenhouse fails to mention the 250 workers at Republic Windows and Doors in Chicago who occupied their factory last December in response to announced layoffs and the closing of the factory. The result was a $7.5 million settlement, giving each Republic worker 8 weeks salary, all accrued vacation pay and 2 months health care. This was admittedly a limited victory, but why not think of it as a "green shoot" of a different kind?