Deepening Debt Crisis:
The Bernanke Reappointment: Be Afraid, Very Afraid
By Prof Michael Hudson
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One popular (and thoroughly misleading) description of Bernanke that has been cited ad nauseum to promote his reappointment is that he is an expert on the causes of the Great Depression. If you are going to create a new crash, it certainly helps to understand the last one. But economic historians who have compared Mr. Bernanke’s writings to actual history have found that it is precisely his misunderstanding of the Depression that is leading him tragically to repeat it.
As a trickle-down apologist for high finance, Prof. Bernanke has drawn systematically wrong conclusions as to the causes of the Great Depression. The ideological prejudice behind his view is of course what got him his job in the first place, for as numerous observers have quipped, a precondition for being hired as Fed Chairman is that one does not understand how the financial system actually works. Instead of recognizing that deepening debt, low wages and the siphoning up of wealth to the top of the economic pyramid were primary causes of the Depression, Prof. Bernanke attributes the main problem simply to a lack of liquidity, causing low prices.
As my Australian colleague Steve Keen recently has written in his Debtwatch No. 42 (http://www.debtdeflation.com/blogs/), the case against Mr. Bernanke should focus on his neoclassical approach that misses the fact that money is debt. He sees the financial problem as being too low a price level for assets to be collateralized for bank loans. And to Mr. Bernanke, “wealth” is synonymous with what banks will lend, under existing credit terms.
In 1933, the economist Irving Fischer (mainly responsible for the “modern” monetarist tautology MV = PT) wrote a classic article, “The Debt-Deflation Theory of the Great Depression,” recanting the neoclassical view that had led him to lose his personal fortune in the 1929 stock market crash. He explained how the inability to pay debts was forcing bankruptcies, wiping out bank credit and spending power, shrinking markets and hence the incentive to invest and employ labor.
Mr. Bernanke rejects this idea, or at least the travesty he paraphrases in his Essays on the Great Depression (Princeton, 2000, p. 24), as Prof. Keen quotes:
Fisher’ s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects.
All that a debt overhead does is transfer purchasing power from debtors to creditors. Bernanke is reminiscent here of Thomas Robert Malthus, whose Principles of Political Economy argued that landlords (Malthus’s own class) were necessary to maintain economic equilibrium in a way akin to trickle-down theorists through the ages. Where would English employment be, Malthus argued, without landlords spending their revenue on coachmen, fine clothes, butlers and servants? It was landlords spending their rental income (protected by
The reality is that wealthy Wall Street financiers who make multi-million dollar salaries and bonuses spend their money on trophies: fine arts, luxury apartments or houses in gated communities, yachts, fancy handbags and high fashion, birthday parties with appearances by modish pop singers. (“I see the yachts of the stock brokers; but where are those of their clients?”) This is not the kind of spending that reflects the “real” economy’s production profile.
Mr. Bernanke sees no problem, unless rich people spend less of their gains on consumer goods and the products of labor than average wage earners. But of course this propensity to consume is precisely the point John Maynard Keynes made in his General Theory (1936). The wealthier people become, the lower a proportion of their income they consume – and the more they save.
This falling propensity to consume is what worried Keynes about the future. He imagined that as economies saved more as their income levels rose, they would spend less on goods and services. So output and employment would not be able to keep pace – unless the government stepped in to make up the gap.
Consumer spending is indeed falling, but not because economies are experiencing a higher net saving rate. The
The problem is that workers and consumers have gone deeper and deeper into debt, saving less and less. This is just the opposite of what Keynes forecast. Only the wealthiest 10 percent or so of the population save more and more – mainly in the form of loans to the “bottom 90 percent.” Saving less, however, goes hand in hand with consuming less, because of the revenue that the financial sector drains out of the “real” economy’s circular flow (wage-earners spending their income to buy the goods they produce) as debt service. The financial sector is wrapped around the production-and-consumption economy. So an inability to consume is part and parcel of the debt problem. The basis of monetary policy throughout the world today therefore should be how to save economies from shrinking as a result of their exponentially growing debt overhead.
Bernanke’s apologetics for finance capital: Economies seem to need more debt, not less
Bernanke finds “declines in aggregate demand” to be the dominant factor in the Great Depression (p. ix, as cited by Steve Keen). This is true in any economic downturn. In his reading, however, debt seems not to have anything to do with falling spending on what labor produces. Taking a banker’s-eye view, he finds the most serious problem to be the demand for stocks and real estate. Mr. Bernanke promises not to let falling asset demand (and hence, falling asset prices) happen again. His antidote is to flood the economy with credit as he is now doing, emulating Alan Greenspan’s Bubble policy.
The wealthiest 10 percent of the population do indeed save most of their money. They lend savings – and create new credit – to the bottom 90 percent, or gamble in derivatives or other zero-sum activities in which their gain (if indeed they make any) finds its counterpart in some other parties’ loss. The system is kept going not by government spending, Keynesian-style, but by new credit creation. That supports consumption, and indeed, lending against real estate, stocks and bonds enables borrowers to bid up their prices, enabling their owners to borrow yet more against these assets. The economy expands – until current revenue no longer covers the debt’s carrying charges.
That’s what brings the Bubble Economy down with a crash. Asset-price inflation gives way to crashing prices and negative equity for real estate and for much financial debt leveraging as well. It is in this sense that Prof. Bernanke’s blames the Depression on lower prices. When prices for real estate or other collateral plunge, it no longer can be pledged for more loans to keep the circular flow of lending and debt repayment in motion.
This circular financial flow is quite different from the circular flow that Keynes (and Say’s Law) discussed – the circulation where workers and their employers spent their wages and profits on consumer goods and investment goods. The financial circular flow is between the banks and their clients. And this circular flow swells as it diverts more and more spending from the “real” economy’s circular flow between income and spending. Finance capital expands relative to industrial capital.[1]
Higher prices in the “real” economy may help maintain the circular financial flow, by giving borrowers more current income to pay their mortgages, student loans and other debts. Mr. Bernanke accordingly sees FDR’s devaluation of the dollar as helping reflate prices. ...
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This brings up the third premise that defenders of Mr. Bernanke cite: the much vaunted independence of the Federal Reserve. This is supposed to be safeguarding democracy. But the Fed should be subject to representative democracy, not independent of it! It rightly should be part of the Treasury representing the national interest rather than that of Wall Street.
This has emerged as a major problem within
Why on earth should the most important sector of modern economies – finance – be independent from the electoral process? This is as bad as making the judiciary “independent,” which turns out to be a euphemism for seriously right-wing. ...
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For Bernanke, the current financial system (or more to the point, the debt overhead) is to be saved so that the redistribution of wealth upward will continue. The Congressional Research Service has calculated that from 1979 to 2003 the income from wealth (rent, dividends, interest and capital gains) for the top 1 percent of the population soared from 37.8% to 57.5%. This revenue has been expropriated from American employees pushed onto debt treadmills in the face of stagnating wages.
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Behind these bad policies is a disturbing body of junk economics – one that, alas, is taught in most universities today. (Not at the
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Financial debt service is not spent on consumer goods. It is recycled into new loans, after paying dividends to stockholders and salaries and bonuses to its managers. Stockholders spend their money on buying other investments – more stocks and bonds. Managers buy trophies – yachts, trophy paintings, trophy cars, trophy apartments (whose main value is their location – the neighborhood where their land is situated), foreign travel and other luxury. None of this spending has much effect on the consumer price index, but it does affect asset prices.
This idea is lacking in neoclassical and monetarist theory. Once “money” (that is, debt) is spent, it has an effect on prices via supply and demand, and that is that. There is no dynamic over time of debt or wealth. Ever since Marxism pushed classical political economy to its logical conclusion in the late 19th century, economic orthodoxy has been traumatized from dealing about wealth and debt. So balance-sheet relationships are missing from the academic economics curriculum. That is why I stopped teaching economics in 1972, until the UMKC developed an alternative curriculum to the
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