Takes on Economic Crisis

The Federal Reserve announced Tuesday morning the biggest one-day reduction of interest rates on record, by three-quarters of a percentage point to 3.5 percent. I read the news with great interest, having just digested a lengthy article on Ben Bernanke, the chair of the Fed as of 2005, in the Sunday NYT. I learned three things about the Fed.

First thing I learned which I maybe already knew

The Fed doesn’t actually increase or decrease the meta-interest rate for the U.S. economy. Times reporter Roger Lowenstein tells us that:

The Fed’s principal power is its control over the supply of money. You can think of the Fed as the banker in a national game of Monopoly. Normally, everyone gets $200 when they pass “Go,” but when business conditions slump, the Fed can give the economy a boost – much like hiking the “Go” rate to $300. Or, if the prices of the little green houses and red hotels are rising too swiftly, it can handout less money.

Then, he gets real technical:

Of course, the Fed doesn’t really hand out money. Its principal monetary lever is something called the federal funds rate, which is the rate that private banks charge one another for overnight loans.

He goes on:

The Federal Open Market Committee cannot “set” the fed funds rate by fiat; when it wants to, say, lower the rate, which as of this writing was 4.25 percent, it directs the New York Fed to inject cash into the system. The New York Fed lends money to major dealers in government securities, taking Treasuries as collateral. (Conversely, to tighten rates, the New York Fed borrows money.) This power to expand the money supply is unique. If one bank purchases bills from another, there is no net change in the banking system’s liquidity. Only the central banker, the Fed, can create new money.

I find this fascinating. I picture this huge bathtub, with us floating like a layer of bacteria on the surface of a rubber ducky, and Bernanke controlling the spigots. The water is turned on by his underlings – lower the interest rate – and the level of the water in the bathtub increases. We all bobble randomly from the waves generated, quite out of our control.

Second thing I learned

Lowenstein recounts for us the history of the Fed Reserve. It was not defined by the Constitution, it was sketched out in 1910 by Paul Warburg of a German-Jewish banking family, Chair of the Senate Finance Committee Nelson W. Aldrich, and other bankers in a secret meeting on Jekyll Island, off the coast of Georgia. Reporters were told, says Lowenstein, Warburg and co. were going duck hunting.

What was setup:

Seven Fed governors in Washington (at the moment there are only five) and the presidents of the Fed’s 12 regional banks, which are dispersed in cities like Richmond and Cleveland, in the country’s industrial centers circa 1913, when the Fed was founded.

The regional Fed banks were to be semiautonomous, and they were chartered with their own boards, whose members were drawn from the local communities and a majority of whom could not be bankers. Political authority was vested in Washington; the Fed’s capital, however, was contributed by private banks all over the country.

The chair that sits at the helm of the Fed is technically independent politically. This is a result of an accord in 1951 that liberated the Fed from the Treasury department. This results in:

Tension with the White House was long part of the Fed chief’s job description, largely because the bank’s dual mandate (fighting inflation and promoting growth) was seen to be in conflict with itself. No president wants inflation, but most want high interest rates even less.

The chair and president historically don’t get along:

William McChesney Martin Jr., who was appointed Fed chairman that year, battled Harry Truman and successive presidents to establish the prototype for an independent Fed chief. It was Martin who proclaimed that the chairman’s job was to “take away the punch bowl just as the party gets going” – in other words, to raise interest rates when a booming economy threatened to cause inflation. And it was Martin who created the quasi legend that Fed chiefs could decide an election. He tightened rates in the latter part of 1959, triggering a recession that began in April 1960. Nixon, the incumbent vice president and Republican presidential nominee that year, blamed Martin for sabotaging his chances in November.

So interesting. Here’s a cool visual history of the Fed, courtesy of the NYT.

Third thing I learned

Capitalists and Marxists disagree about what causes crises. I suppose I should have known that already, but the mainstream economist version is so kooky:

Early scholarship blamed the Depression largely on Wall Street speculators, who were thought to have fueled overexpansion by businesses. Milton Friedman and Anna Schwartz, however, fingered the Fed for failing to adequately expand the money supply as the economy contracted. That view is now widely accepted, and Bernanke’s scholarship added a dimension by emphasizing the pivotal role of banking panics in aggravating the monetary failure.

How can turning on the spigot solve a recession? More money, more liquidity, more waves lapping the bathtub doesn’t mean that more workers are gainfully employed and a chicken is in every pot daily. Doesn’t it just mean that everything is just more expensive, that prices are raised up a notch, in other words inflation?

I am puzzled by this. I try to resolve this by taking a closer look at the Great Depression and what the Marxist and capitalist takes on it are.

Marxist take on the Great Depression

Marx’s formula for capital in Vol. 1 of his hefty brick Capital is:

M—C—M + ∆M

Where M = money, C = commodity, M+∆M is the money the capitalist gets back for her commodity in the market, with added surplus value

Capital has several internal contradictions which will ultimately lead to its demise, according to Marx although he conveniently omitted a timetable. One of them is the problem of underconsumption, which affects the part in the circulation of capital where a commodity is exchanged for more money, the capitalist pocketing the profit. When this crisis occurs, people don’t want to spend money for commodities, they hoard money, and the water in the bathtub gets absorbed by fat little sponges holding their breaths.

My notes from the class with rockstar David Harvey say that various solutions are proposed.

• Malthus thinks foreign trade will create demand,
• Luxemburg thinks primitive accumulation will create new demand, and
• Keynesians think state monetary policy will create demand.

I turn towards Bernanke’s hero Milton Friedman for orthodox economists’ take on this.

Milton Friedman on the Great Depression

I learn from Friedman’s essay on “Monetary Policy” published in the Proceedings of the American Philosophical Society, Vol. 116, No. 3. (June 9, 1972), that Keynesians differ from Friedmanites.

Keynesians – believe in fiscal policy, the state should spend more money to spur on demand

Friedmanites – swears by monetary policy, where the Fed Reserve should concern itself with increasing the quantity of money (the level of bathwater) and thereby sparking economic growth

Friedman shares with us a series of graphs that show the positive relation between money stock and income.

(I will insert charts 1-3 here.)

Increasing the quantity of money — flooding the bath, disturbing your downstairs neighbor with a water leak — doesn’t lead to rampant hyperinflation, as one would guess because of this logic:

The price of money is not the interest rate but the amount of goods and services that have to be given up to acquire a unit of money. An increase in the quantity of money tends to lower the price of money because it tends to raise the money prices of goods and services and thereby lowers the amount of goods and services that have to be given up to acquire a unit of money. And conversely for a decrease in the quantity of money.

And, if trade unions and proponents of a living wage would shut up, the “rigidities” would decrease the natural rate of unemployment. Therefore, the Phillips curve — unemployment and inflation are inversely related, therefore when the inflation rate increases, unemployment decreases — would lose its skew towards unemployment in the short-term.

Friedman goes on in his article to say how monetarists such as himself have been woefully misunderstood and ignored, much to the detriment of the U.S. economy. And, he raises his freak flag for a small, neoliberal state, where:

The private-enterprise market system is inherently stable, provided only that there is a stable monetary framework, and that past instability has been produced primarily by erratic and unwise government intervention rather than by any inherent instability in the system itself.

Therefore, the role of monetary policy is:

To adopt measures that will lead to growth in the stock of money at a fairly steady rate roughly equal to or slightly higher than the average rate of growth of output.

I’m not sure where I’m going with all of this. Friedman’s pronouncements of the Philips curve has momentarily absorbed me, and I feel that I must read this definition of the crisis of overproduction by Patrick Bond printed out and sitting neatly on my desk before I further expound on a Marxist critique of Friedman and his acolytes, including Bernanke.

I will end my inaugural post on this blog in an admittedly childish way: Follow this link to watch a clip about the Biotic Baking Brigade, a global pastry uprising, who pied Friedman in 1998 (I’m still trolling the WordPress manual on how to share video, bear with me).

And, another gratuitous play for laughs: Bernanke-themed comics.