Wesley C. Marshall
The global financial crisis that erupted in 2007 struck at the heart of the global economy. It not only occurred within the world’s most powerful economic institutions in the geographical center of economic power, but the enormous sums of money involved also forced many to rethink the nature of money, reaching the heart of economics as an academic discipline. The meteoric rise of the shadow banking system (SBS) and its collapse and bailout lead to the irrefutable observation that money is not scarce. The subsequent global policy of propping up financial asset prices while restricting productive investment, employment, and production is neither economically nor politically sustainable. However, the alternative of abundant funding for full employment and production is also problematic, as simply producing more smoke and steel can no longer be a way forward.
This chapter draws on the traditions of institutionalism and Post Keynesianism in order to demonstrate how we have arrived at our current juncture, and uses the guidance of Keynes to point towards a set of basic principles and structures that can attend to the needs of a truly transformative alternative to today’s financialized global morass. Only after the non-scarcity of money is openly recognized and understood by society can the perhaps even more difficult task of working towards the realization of full human potential in the face of existential threat be undertaken. As will be argued, the many historical lessons offered by global finance point to the fact that designing global, regional, national, and local financial structures for such a task can be done. In order to provide for greater production and employment under the guidance of human advancement, the most difficult part will be attaining the minimal public understanding of finance necessary to establish the political will to restructure the financial system.
To show how a democratically determined financial system at the service of humanity has worked in the past, and why economic interests have created a public misunderstanding of finance and its operations in order to exclude the possibility of this happening again, this chapter is organized in the following way: first, we examine how mainstream economics disingenuously deals with institutions that can create money out of nothing. Then, we explore the nature of these institutions and how they are controlled. We then turn our focus to banking in order to synthesize our main points regarding the integral functioning of public and private finances and their appreciation within society as a whole, in order to close with several considerations regarding abundant money and its potential uses and abuses in current society.
Following the Veblenian tradition of critically associating institutions with economic power, this chapter looks at the three key money-creating institutions and pillars of the financial system in the United States (US)—the central bank, the treasury, and private banks—under the key fundamental assumption that a handful of global banks constitute the dominant political faction of capital in current western capitalism.
In past decades, as the academic debate regarding the monetarist counter-revolution gave way to the debate over financial globalization and then to financialization, a small group of global banks was gaining ever greater economic and political power. The growing dominance of these banks is at the center of financialization, succinctly defined by Epstein (2005: 3) as “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operations of domestic and international economies.” Such financial motives have conquered the market discipline of capitalism, as most clearly manifested by the too big to fail phenomenon, as well as the legal discipline of governments, as shown by the too big to prosecute doctrine.
The monopolistic power of global banks is easily seen in the domestic concentration of banking sectors that have later gone on to conquer other ones in the process of financial opening that has happened around the world. As we argue here, stemming from their core desire to be the monopolistic provider of credit, a handful of global banks that now dominate many economic and political systems have actively promoted a thought system that consistently rails against the state, lies about its abilities, and promotes laws to restrict its money-creating capabilities. National spaces of production have been transformed into international arenas of concentrated financial control. We certainly agree with Keynes’ sentiment that “when the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill done” (Keynes 1936: 159), except that these banks are not only monopolistic but ‘criminal.’
As a result of decades of national policies of financial deregulation, de-supervision, and de facto de-criminalization—the three D’s identified by Black (2005)—an increasingly criminogenic system has been created in which fraudulent practices have driven out legitimate ones. This fundamental driver of the financial crisis, originally and forcefully argued by Black and appreciated by James Galbraith (2014) in his most recent book, greatly explains how and why the largest and most important financial markets, such as foreign exchange, and prices, such as the London Interbank Offered Rate (LIBOR), have all come to be dominated by a handful of banks who systematically and criminally manipulate them (US DoJ 2015).
Yet to appreciate the evolution of money-creating institutions, the evolution of an institution that does not create money—academic economics—is also of great help. As Charles Ferguson showed in his documentary Inside Job, elite members of the academy have been bought off by the banking industry, a point taken up from academia by DeMartino (2011) and further developed by Ferguson (2013) himself.
Much as we can historically divide with some precision the golden and leaden ages of capitalism with the ending of the Bretton Woods monetary system in 1971, we can also set as a historical marker Hayek’s winning of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel in 1974 as the beginning of what Paul Krugman (2009) termed ‘the dark age of macroeconomics.’ In Hayek’s prize acceptance speech, he claimed that as societies we should never attempt to master the forces of our social world. An openly avowed obscurantist winning a scientific award is worrisome, and indeed Hayek began the tradition of neoliberal economists being awarded the Nobel prize, despite repeatedly showing themselves to be poor ‘scientists,’ consistently getting wrong the issues that are most important for society and those that are supposedly their professional strengths (Black 2014).
Hayek (1944: 211) argues for the only acceptable possible existence of spontaneous market order, and that any sort of formal planning could only have disastrous consequences:
Those who argue that we have to an astounding degree learned to master the forces of nature but are sadly behind in making successful use of the possibilities of social collaboration are quite right so far as this statement goes. But they are mistaken when they carry the comparison further and argue that we must learn to master the forces of society in the same manner in which we have learnt to master the forces of nature. This is not only the path to totalitarianism, but the path to the destruction of our civilisation and a certain way to block future progress.
Instead of arguing for greater knowledge as a force against overzealous, crooked or poor planners, Hayek (1944: 208) argues for less knowledge:
there are fields where this craving for intelligibility cannot be fully satisfied and where at the same time a refusal to submit to anything we cannot understand must lead to the destruction of our civilisation. . . . A complex civilisation like ours is necessarily based on the individual adjusting himself to changes whose cause and nature he cannot understand.
We would counter with Joan Robinson’s (1960: 17) saying that “the purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.” Indeed, from the early 1970s onwards, a dominant faction of mainstream economics has succeeded in essentially fooling all the people all the time. The political movement that was born in 1947 at the inaugural conference of the Mont Pelerin Society (MPS) and that originally called itself neoliberalism, was initially led by Hayek (Mirowski & Plehwe 2009; Burgin 2012; Mirowski 2013). The reins were then gradually passed to Milton Friedman—a co-founder himself—as his self-denominated ‘monetarist counter-revolution’ (Friedman 1970: 1) was making important inroads in public policy spheres.
The dumbing down of economics, which accompanied the increasing operational control of neoliberal economics over public policy, has been a two-pronged movement consisting of a publicity campaign designed to change public opinion, and of a purge of academic dissenters. Indeed, one of neoliberalism’s great victories has been to convince societies at large that inflation rather than unemployment is humanity’s greatest problem, and this can be seen as an important clue as to why banks seek to suppress knowledge. Unemployment is a fundamentally human problem, as the lack of employment opportunities devalues human existence, while inflation is fundamentally a banking problem—or at least a perceived banking problem. The propaganda efforts of neoliberalism, and of Friedman in particular, can best be seen in his PBS documentary Free to Choose (1980).
Efforts were made to change expert opinion as well. As Mirowski & Plehwe (2009: 7) notes, “among the key tasks perceived by MPS leaders was a neoliberal reeducation of capitalists.” The evidence that the neoliberal economists who have led the monetarist counter-revolution are systematically paid for by banks and other financial institutions (Mirowski & Plehwe 2009; Mirowski 2013; Ferguson 2013) strongly suggests that the ever greater social dominance of neoliberalism has been a bank-led exercise in economic control. Indeed, Hoover (2003: 184) reports of a diplomatic cable at the end of the Second World War stating that “Wall Street looks on Hayek as the richest goldmine yet discovered and are peddling his views everywhere.”
Mirowski (2013) has made an important contribution in highlighting Hayek’s crucial role in creating Chicago school economics, and provided evidence to connect the interests of Wall Street and the school of thinking that has produced the greatest amount of academic backing for legislation that favors Wall Street.
The academic dominance of neoliberalism is well described by James Galbraith (2014: 70):
Even those who objected with this vision had to engage with it. The layered complexity of the vision, the subtlety of the claims, meant that it took mental effort to come to grips with what was being said. To articulate a dissent without becoming a heretic was a difficult task. The profession would reward those who kept just a few points of departure from the pure model, and punish the rest. In this way, the debate stays within the tribe, and the purists, though sometimes embattled, preserve their importance.
In mainstream economics, any serious analysis about the nature of money, how it is used in reality, or how money-creating institutions can restrict the creation and circulation of money are strictly off-limits. The division of academic economic teaching between freshwater and saltwater economists (Galbraith 2014), who can get things wrong in different and predictable ways because they omit, eschew, or frankly lie about the most important facts in their analyses, leaves us with the pincer of neoliberal economics.
By enabling the claim that macroeconomics is fully characterized by a divide between new Keynesian and new classical macroeconomics, new Keynesianism closes the pincer that excludes old Keynesianism. As long as that pincer holds, economics will remain under Friedman’s shadow. Breaking the pincer requires surfacing the role of Friedman’s thinking in new Keynesian economics and making clear the distinction between old Keynesian and new Keynesian economics.
Palley 2015: 632
Galbraith (2014) and Palley (2015) come to similar conclusions. Much like Palley’s neoliberal pincer, Galbraith speaks of the common methodology of both the freshwater and saltwater economists that knits them into a single community of ‘serious economists,’ excluding all others:
a few economists challenged the assumption of rational behavior, questioned the belief that financial markets can be trusted and pointed to the long history of financial crises that had devastating economic consequences. But they were swimming against the tide, unable to make much headway against a pervasive and, in retrospect, foolish complacency.
Galbraith 2014: 80
Such complacency may have been foolish, but the above researchers have shown that it was not unintentional. Indeed, the only scholars to get the crisis ‘right’ to varying degrees fall outside of the narrow limits of Palley’s pincer: They represent the heretics that mainstream economics have made into “the unpersons of the profession” (Galbraith 2014: 80). To better appreciate the process through which critical economists were either purged from academia or pushed to its sidelines, there is no better guide than Fred Lee’s A History of Heterodox Economics (2009), which goes through in great detail how the parameters used to evaluate academic success are continuously stacked against anyone who falls outside of the narrow freshwater-saltwater divide.
Adding together the components of economists who are paid by banks or other financial companies, and that execute public policy that rewards failed banks at the expense of employment, we can understand financialization as the takeover of society by banks and other private money-creating institutions. We can therefore understand how academic economics has become an appendage of these interests and how the concurrent ‘dark age of macroeconomics’ is simply the creation and propagation of an obscurantist pseudo-science at the service of banks. Again, the application of an institutionalist perspective means that this should come as no surprise.
On the right side of the neoliberal pincer, from Friedman’s views on money, to Stigler’s regulatory capture, to Buchanan’s public choice theory, and to Myerson’s pleas for higher CEO pay in order to keep them from committing financial crimes (Black 2014), the Chicago school’s Nobel prize winning economists consistently had their prophesies come true. Statements of how reality works that were absurd at face value when originally presented have become accurate descriptions of reality as the Chicago school’s promotion of the deregulation, de-supervision, and the de facto de-criminalization of banking activities has fundamentally changed how financial systems work. On the other side of the pincer, we have a group that operates under a moniker—New Keynesians—that has little to do with its namesake, and that has had open adherents in the most important positions of power, such as Ben Bernanke and Mario Draghi.
In order to comprehend the victory of the monetarist counter-revolution in academic economics, the partial victory of Keynes’ revolution must also be understood, for both it and its succeeding monetarist counter-revolution were top-down affairs. John Kenneth Galbraith notably referred to Keynes’ as the Mandarin Revolution (Galbraith 1977: 224). Similarly, the subsequent monetarist counter-revolution, which led to the leaden period of capitalism and continual crisis, can most clearly be seen as an elite dominated coup d’état that occurred above the heads of democratic societies.
The Keynesian revolution, aimed at controlling state finances in order to eliminate unemployment, offered a brief historical respite from this scourge of humankind, establishing the financial conditions for full employment in many countries around the globe. While the steering wheel of state finances was used to attend to human demands, the grip of informed electorates over it was always tenuous. The political gains of the New Deal and those of post-war Britain that supported Keynes’ revolution would certainly point to the conclusion that, at least in some times and places, the citizenry could identify full employment as a priority and as an achievable political goal. But even while at the operational level money and state finances were used towards the goal of full employment, the use of functional finance was only tenuously incorporated into the social sciences at the academic level. So while much of the electorate could certainly understand the importance of eliminating unemployment, the ways of getting there—the lessons of functional finance—never reached a critical permeation in academia or politics, and were washed away with disappointingly few taking note.
In the General Theory, Keynes (1936: 33) cryptically alludes to the “powers behind authority” and their support for the ‘Ricardian economics’ that held such sway over British society at the time of the General Theory’ s writing. But Keynes’ views on money were likewise cryptic. Trying to tease out Keynes’ real understanding or opinion on the nature and role of money in society is an almost impossible task, for as Smithin (2013) points out, Keynes’ conceptions of money both evolved and maintained contradictions throughout his writing. Many have suggested that Keynes was employing some sort of strategic ambivalence, for reasons explored below.
Reading more of Keynes is a good cure for such doubts. The New Keynesians, however, tread in the opposite direction. The only element of Keynesian thinking that really enters into their policy recommendations is the IS-LM curve—what the self-identified New Keynesian Paul Krugman (1998) called “the workhorse of practical policy analysis in macroeconomics.” It is problematic for a group of economists to proclaim themselves Keynesians when they rely so heavily on only one of his supposed ideas. It becomes even more problematic when one considers that the IS-LM curve was never even suggested by Keynes himself. It becomes even more problematic when the man who did invent the IS-LM curve—John Hicks—formally recanted his invention (Davidson 2008).
Krugman (1998) states that the IS-LM curve is “not fit to be seen in polite intellectual company,” yet he bases his policy recommendations on it. Considering the glaring lack of theory on banking (Smithin 2013: 252), and the fact that declared experts on the Great Depression cannot even contemplate bank failure as they “are not historians” (Bernanke 2000), reality becomes even more worrisome. When the same renowned academic heads the world’s most influential central bank, then we are really in a dark age, in which the New Keynesians, the only public figures that associate themselves with the political left, cannot countenance banks damaging the economy, or the role of functional finance in healing it.
In order to briefly trace the thread of how the most important money-creating institutions are consistently misrepresented by academia and how such institutions are used to favor the interest of banks over the interests of the public at large, we focus on the ontology of these institutions and their operations.
We begin our analysis with government spending. In his opinion piece mentioned earlier, Krugman (2009) puts forward several arguments against John Cochrane, who argues that “first, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend. . . . This is just accounting, and does not need a complex argument about ‘crowding out’.” Krugman’s response to Cochrane is that “what’s so mind-boggling about this is that it commits one of the most basic fallacies in economics—interpreting an accounting identity as a behavioral relationship.” Krugman correctly identifies Cochrane’s error—government accounts are nothing more than accounting identities— but then Krugman goes on to commit the same error: “Yes, savings have to equal investment, but that’s not something that mystically takes place, it’s because any discrepancy between desired savings and desired investment causes something to happen that brings the two in line.” An accounting identity means that no mystical actions are needed. It is simply a rule. If the government spends more on roads in a year than it takes in through taxation, that is a fiscal deficit.
Krugman once again does what he accuses Cochrane of. As opposed to “what mystically takes place,” what “causes something to happen” leads the reader into a macro model, where desired savings and investment meet at an equilibrium point. This is a behavioral relationship, not an accounting relationship, as Krugman strongly implies.
Krugman could have simply accused Cochrane of flat out lying: “every dollar of increased government spending must correspond to one less dollar of private spending” is exactly what the accounting relationship does not say. We posit that Krugman must confuse the issue so much because the definition that public deficits are always a subsidy to businesses and households is such a bold political statement in itself. Krugman ends the opinion piece lamenting the “dark age of macroeconomics,” while only muddying the issue himself. Seccareccia (1995) attended to this issue convincingly decades ago. As Baragar & Seccareccia (2008: 82) argue, this accounting identity by no means implies that private and public spending have to “even themselves out.” Both can grow, or shrink, at any rate, but they always maintain the same relationship.
The neoliberal pincer therefore holds on public finance. Cochrane on the right and Krugman on the left both get it wrong in different ways, and the public is left without an explanation of the theoretical possibility of functional finance. Krugman bases his consistent support for the ‘fiscal restriction’ approach on the maxim that “yes, savings have to equal investment.”
True to Palley’s pincer or Galbraith’s exclusionary saltwater-freshwater spectrum, public opinion is trapped between two misrepresentations of the truth, as also happens with public discourse regarding monetary or credit policies. The New Keynesian corollary to Bernanke’s willing omission of the role of banks in the history of America’s financial crises can be found in Krugman’s inability to countenance the potential of money creation by banks. Krugman both ignores and omits the basic rules of monetary accommodation of the Federal Reserve (Fullwiler 2012), as well as the existence of an interbank market from which the SBS was spawned. By treating all money as exogenous—only available if the state prints it, and never created by banks—Krugman eschews even Friedman’s understanding of ‘inside and outside money,’ referring to the money created by banks from the money created by the state (Friedman & Schwartz 1987).
Within the exclusionary saltwater-freshwater pincer, neither banks nor governments can create credit or money out of nothing more than social agreements, a proposition that has become ever less tenable in the face of the creation of more than US$ 800 trillion worth of derivatives and structured financial products in less than 20 years, and the US banking bailout of somewhere around US$ 30 trillion (Felkerson 2011). Such a massively obvious exception to standard economic theory has led to much questioning of economics as a profession.
If we can build on the metaphor of the government holding the steering wheel of the car, which represents the state (Forstater 1999), we would like to add that there are two sets of brakes and accelerators (we will assume it is an automatic car). One set corresponds to monetary policy, and the other to fiscal policy. In both cases, the brakes are designed to take money out of circulation, and the accelerators to put money into circulation. On the fiscal side, the accelerator is the fiscal deficit, and the brakes are taxes. If the driver wishes the engine to engage—for the economy to expand—s/he can push more money into the economy through a variety of delivery methods, including public works, transfer payments, subsidies, public companies, public employment programs, etc. When a government spends nothing, the engine does not move out of state stimulus. This does not mean that it cannot move on its own. But if the driver wants to slow the economy down through fiscal spending, s/he can surely do so by stepping on the brake and applying taxes. The fiscal balance measures whether the state is giving or taking more or less money to the economy as a whole. If we had, for example, a 100 percent fiscal surplus, this would mean that the government would only be taking and not giving anything.
Under Lerner’s (1943) functional finance, the fiscal accelerator should be applied through bond issuance. In this case, money is created ex nihilo, but not to a great degree. If a country runs a permanent deficit of 5 percent, the government has simply opted to forward investment, employment, consumption, and profit, later to be taken back in the form of taxes and returned to bondholders. But to assure economic expansion, more must be given than taken. This task is facilitated by the fiscal multiplier: as money is forwarded, it is multiplied as well. During the golden age, experience showed that countries can forward spending, or run fiscal deficits, in a perfectly sustainable fashion.
The monetary brake and accelerator have an extra step between them and the engine of the economy in general: banks, the gatekeepers of credit. This makes the monetary brake—the application of interest rates above the break-even level of profit expectations and interest rates— particularly effective. If a government is willing to raise interest rates to 25 percent and credibly guarantee its payment, then banks and other capitalists will invest more in government debt and less in productive investment and employment. Additionally, at least some amount of consumption should be directed towards savings. Whereas a government can run surpluses and hold on to more money than it pushes out into the system, banks can also hold on to more money than they lend out. This most commonly occurs when the central bank applies the brake. If the government does nothing, and simply allows private non-monopolistic banks to set the interest rates, no brake is applied by the state. However, under monopoly conditions, the banking system itself can apply the brake.
The accelerator of monetary policy is mostly ineffective, and when used, tends to simply ‘flood’ the engine. As years of zero interest rate policies and multiple rounds of ‘quantitative easing’ have shown, the accelerator is ill-suited for the task of getting the economy moving. The monetary accelerator only reaches the main engine of the economy through the antechamber that is the banking system. It is this element that the fiscal accelerator does not pass through on the way to the motor, that can become ‘flooded,’ when banks cannot or do not want to lend out the money that the state is pushing out. This phenomenon, academically known as ‘pushing on a string,’ can last indefinitely. Understanding the basic structural limitations of monetary policy helps to understand why this is.
With the monetarist counter-revolution well underway, John Kenneth Galbraith (1975: 305) notably stated that “only the enemies of capitalism will hope that, in the future, this small, perverse and unpredictable lever will be a major instrument in economic management.” These words would prove ever more true a decade later, under the economic stewardship of Reagan and Thatcher.
Four decades after Galbraith’s observation, years of continually applying the monetary accelerator have not only failed to get the economic motor going sufficiently, but have not changed mainstream economists’ preference for using monetary rather than fiscal policy. This situation reflects the passing of the control of the car to those who represent bank interests, while simultaneously demonstrating how the monetary accelerator is only attached to money center banks. The overall economy is not awash with cash; it is only the banking sector ante-motor that is flooded. Yet neither side of the pincer relinquishes their obscurantism regarding how our current banking system creates and distributes money.
Fortunately, the debate around banking and macro financial issues does not occur in a vacuum, and there are concrete historical results that clearly point to the varied performance between different types of capitalism: golden age Keynesian versus leaden age Friedmanian. For us to understand why for 30 years the western world could grow at around 6.5 percent annually during the golden age of the post-Second World War as opposed to around 2 percent during the leaden age, with similar rates of inflation, we must understand how the international financial system operated, as well as appreciate the widespread application of functional finance under distinct national systems of production. Likewise, in order to understand why there were no systemic financial crises during the golden age period, we must rise above obscurantism and understand how banking systems operated and have changed. Let us start from the latter point.
The Organization for Economic Cooperation and Development (OECD) states in its Bank Competition and Financial Stability that
In very broad terms, there are two quite different types of financial products:
1 Those primary instruments associated with consumption, savings and fixed capital formation that create wealth (usually associated with loans for trade credit and working capital, and securities – equity and debt); and
2 Those associated with wealth transfer between economic agents in the attempt: to hedge risks; to arbitrage prices, to gamble; and to reduce tax, regulatory and agency cost (management fees, custody, brokerage, etc.)
OECD 2011: 36
The OECD distinguishes two forms of banking, with the first being more prevalent in the golden age, and the second in the leaden age. For expositional clarity, we can likewise take the example of housing in the two periods, in order to emphasize just how different macro outcomes can be under the two systems. In the US, housing was left to private banking, done at the local level through Savings and Loans (S&L) institutions. During the 1930s, the US Congress conferred upon S&Ls the role as principal agents of national housing policy. At the level of the federal government, during the golden age, regulations and subsidies guaranteed that fraud and bank failures were at a minimum (NCFIRRE 1993). Under these circumstances, popularized fairly accurately in Frank Capra’s It’s a Wonderful Life, banking is a relatively decentralized, unprofitable, and boring affair. Productive banking as above classified by the OECD can be seen through the 3×3×3 standard: pay depositors 3 percent, charge 3 percent more for loans, and be on the golf course by 3.
Issuing a home mortgage is an easy task for this type of banker. When examining a loan application, the banker can feel sure that the client will be good for her payment, provided that she is gainfully employed and has good recommendations. The credit agent can also feel sure that the client would be able to pay off her loan, as thanks to an active fiscal policy mass unemployment was unheard of. The credit agent therefore makes one bet on the creditworthiness of the individual and another on macroeconomic conditions. Again, under such conditions, such bets are easy and their payoffs are low. But this is the essence of banking serving its customers and the economy in general. With a handshake the credit circuit is born, and money is created from nothing, but only to a small degree in this case, as bets are small and risks are low.
Under Lerner’s (1943) vision of functional finance, the accelerator of fiscal spending must be continually applied if both capital accumulation and production and employment are to expand. Continual deficits of, say, 5 percent, provide subsidies to families and businesses. Much of this subsidy is directed at maintaining a welfare state, where retirement, education, health care, and transportation are subsidized. With more disposable income to spend, aggregate demand and business profits rise. People can live with basic guarantees of living and can simultaneously act as vehicles between fiscal spending and business profits. During the golden age, functional finance and decentralized productive banking went hand in hand, and megabanks and monetary policy had little place.
Such traditional financial intermediation between savers and lenders was the result of a financial system designed for banks to be at the service of the economy, and not the other way around. The regulations enacted in the 1930s attended to the necessary conditions of such a system: banking was decentralized in its market structure; bets were relatively safe and spread thinly over the economy; opportunities for conflicts of interest between banks and their clients were minimized; and a system of regulation and supervision was established and maintained. The contrasts with the conditions that created the 2007–2009 crisis could not be more clear. While in the above scenario banks could be rightly called financial intermediaries, global banks can now be rightly called fraud intermediaries. Whereas risks were previously small and atomized, today they are centralized and world-stopping.
The subprime crisis arose in large part from the criminogenic environment created through decades of financial de-regulation, de-supervision, and de facto de-criminalization of the banking system. Once the Glass–Steagall Act was revoked in the US, commercial banks could again write bonds backed by future mortgage payments—the process of securitization. This fundamental transformation meant that it was often more profitable to sell off packaged loans than to hold them through to maturity. As volume was key to profits, and as financial fraud was no longer punished, banks had every incentive to massively defraud clients. On the front end, mortgages were fraudulently peddled to retail customers, while on the back end, structured financial products were fraudulently sold to institutional investors.
While apologists for bank interests state the mortgage fraud ‘epidemic’ (in the words of the FBI in 2004) was caused by the Community Reinvestment Act (FCIC 2011), they have few answers as to how or why these fraudulent loans claimed their first victims on the back end in Germany in 2007. The transition from a legitimate system that aligned bank interests with those of its clients to a criminal system in which banks could defraud with impunity, did not hurt only the retail customer.
As revealed by the Financial Crisis Inquiry Commission (FCIC), the ratio of managers’ profits to debts created through collateralized debt obligations (CDO) was between approximately 1 to 50 and 1 to 100, depending on the complexity of the deal (FCIC 2011: 131). As such, the end result of defrauding clients on both ends of the CDO were profits for individual actors, and astronomical levels of debt that have been used to guarantee political impunity for banks, most clearly seen with the too big to fail–too big to prosecute doctrines. Incentive structures have been completely inversed since the golden age. Whereas banks were at the service of the economy in general before, now their profits often come from bankrupting clients on both the retail and wholesale level, and their political survival depends on how much damage they could potentially inflict upon the economy, in a current application of Kalecki’s (1943) proposition that the captains of industry would sacrifice profits for political control.
The above quote from the OECD (2011) arrives as the core dynamics of traditional banking, of great benefit to the average person but not to the criminal banker, and offers great contrast to the shadowy banking system that entered into crisis in 2007. The OECD’s insight is also helpful to our argument here, as it underlines how different structures can produce different results regardless of time. Appeals to return to a system that worked well before are often casually brushed aside as nostalgia, confusing how a system worked with a certain point in history.
This is why understanding the ontology of finance and understanding why some systems work better than others is such an important—and perhaps unsurprisingly unattended—area of study. Indeed, as helpful as the OECD quote is, it does not include the almost pure monetary creation of some parts of the SBS, nor does it explicitly mention fraud.
As we have tried to emphasize, if finance is to attend to the creation of investment, employment and wealth, it must attend to several core concepts. Banking must be decentralized, supervised, and regulated. The elements of the SBS that acted as the fraud intermediaries that drove the 2007–2009 crisis could not have operated if anti-monopoly and anti-fraud laws were applied. On a national level, a humble yet functional banking system has no need for a strong central bank, and fiscal policy—and not merely private bank loans—should be the mechanism used to assure that the economy is constantly and consistently forwarded money. In order to guarantee the international conditions for such policies, stable exchange rates and relatively closed financial systems are needed for national spaces of production to be relatively protected from what would otherwise be rough and disruptive seas of global finance. In the golden age, such financial stability led to lower interest rates and the possibility of long-term and stable productive investment.
If economics as a social science should come to grips with the social convention of money being at the service of democratic and enlightened societies, then we must ask whether societies at large can responsibly manage the possibility of abundant money. To put it in less moral terms, given the planet’s rapidly deteriorating ability to comfortably accommodate human life, considerations over whether functional finance would simply be adding fuel to the unsustainable material ambition of today’s world must be addressed. Yet to address these we must return to a focus on morals. Keynes’ (1931: 332) famous passages from ‘Economic possibilities for our grandchildren,’ that “for at least another hundred years we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is not,” hints at why he did not lay out functional finances as formally and clearly as Lerner did.
At the beginning of the 1970s, Schumacher (1973) offered the criticism that Keynes erred in calling for an advance towards the light through darkness. While Keynes’ academic ambiguity regarding money certainly left room open for economists at the service of banks to greatly contribute to the conditions that created today’s global financial morass. The ongoing global financial crisis on the other hand offers an unprecedented opportunity for Keynes’ moral and political considerations regarding monetary abundance to be revisited, particularly in light of the increasingly clear motivations behind the obscurantism and false science that define the neoliberal pincer.
Indeed, as we are now almost a hundred years removed from the writing of Keynes’ above quote, perhaps we should now ask whether we need to still pretend about money. But if there were to be a general recognition of the non-scarcity of money, then how should we use it?
Keynes provides guidance on the political and moral front. Although strictly speaking of the right to national self-sufficiency—and certainly most applicable to that—the below quote resonates with the basic premise of establishing functional finance in order to allow society to make informed decisions regarding spending. Once freed from the money motive, society can work towards what is truly worthwhile as it sees fit. Similarly, once countries can break their economic dependence from foreign financial actors and markets and become self-sufficient, nations as a whole can
be our own masters, and to be as free as we can make ourselves from the interferences of the outside world. Thus, regarded from this point of view, the policy of an increased national self-sufficiency is to be considered not as an ideal in itself but as directed to the creation of an environment in which other ideals can be safely and conveniently pursued . . . that we all need to be as free as possible of interference from economic changes elsewhere, in order to make our own favorite experiments towards the ideal social republic of the future.
Keynes 1933: 760
Demands for both full employment and dignified work are not mutually exclusive; capital productivity and full employment may be, however, particularly when there are no barriers in place to assure that capital and the forces of production share the same spaces and fates. If we are to guarantee a productive system and a financial system at the service of “our own favorite experiments,” hopefully led by the effervescent creativity of the young from below, we must decentralize both our financial and productive systems. Despite many opinions that there can be ‘no going back’ in finance, we propose that the basic financial architecture of the US and the globe under Keynes’ international monetary system was correct in spirit and function: a global system that minimizes international financial flows and maximizes home-grown credit and work, supported at the local level by a variety of credit institutions from which to start ventures, and at a national level by a system of functional finance in which the average worker can always have a month’s advance instead of always being a dollar short.
As Galbraith (2008) mentioned towards the beginning of the crisis, simply increasing government payouts through already existing programs is an easy way of creating aggregate demand and improving social welfare. Government deficits can more easily and effectively go towards subsidizing everyday citizens than bailing out banks. Simply increasing social security payments, cutting tuition to state schools while adding more faculty and staff, or expanding the role and depth of Medicare, represent frictionless government subsidies paid at the household level. A basic appreciation of how our financial systems operate should eliminate controversy regarding this statement.
Perhaps achieving a general appreciation for a stable financial system is a more ambitious task than the creation of one. To insist, a stable financial system has much more to do with form and function than space and time. If the US and other countries are to once again have their private and public money-creating institutions act in concert with human advancement in mind, we will need: on the one hand, academic economists willing to rise above the neoliberal pincer and embrace the reality of money’s non-scarcity—a calling that Post Keynesian economists have consistently embraced; and on the other hand, we will need public opinion at large to understand that attention to employment and consumption based on human needs and dignity—rather than the invidious accumulation of material goods—should be the end goal of that stable system and abundant money.
We certainly sympathize with Keynes’ skepticism. Much like during his times, today’s society may not be prepared for this. However, at this critical junction, we conclude that this is our only possible way forward. Today’s elite, guided by materialism and obscurantism, has clearly failed humanity. We hope that society can now truly heed Schumacher’s (1973) position—which was never that far from Keynes’—that the only way out of the darkness of ignorance and into the light of knowledge and consciousness is through the path of truth, morals, and social science at the service of humanity.
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