from the pages of
In late August, the world's most prestigious central bankers and their learned acolytes from academia and the news media all converged on the resort town of Jackson Hole. An annual gathering sponsored by the Federal Reserve Bank of Kansas City, last August's symposium took up the issue of "unemployment--what causes it and how policy can effect it," in Fed chairperson Alan Greenspan's words, convening the weekend's events.
"[A] rise in the natural rate [of unemployment], rather than inadequate demand, is the main source of the unemployment problem in advanced economies," Stanford University economist Paul Krugman maintained. "[G]rowing U.S. inequality and growing European unemployment are different sides of the same coin."
Policymakers therefore face a choice between the U.S. and the European models: either more jobs at lower wages, along with greater inequality and fewer social programs; or fewer jobs at higher wages, less inequality and more generous social programs. But not both.
"Of concern to central bankers...is the fact that if the trade-off that Krugman outlines is as stark as it appears, those endeavoring to address structural employment imbalances are occasionally bound to find themselves frustrated when confronted with so dissatisfying a choice," Greenspan noted at Jackson Hole. "Any tendency to seek a bit of macro policy relief by pushing on the outer limits of monetary policy risks longer-term financial instability," he added, coming about as close as a central banker dare come to telling it like it is. The general population be damned, these comments suggest.
Call it the policymaker's dilemma. What's good for the many is bad for the few (on principles that central bankers and professional economists understand with impressive clarity, as Greenspan and Krugman will attest). Unless policymakers want to trigger a financial earthquake that registers a near-10 on the Richter scale, sooner or later it'll dawn on them that they better cater to the right class of interests. Otherwise, "longer-term financial instability" will result, as Greenspan was correct to point out. Thus the problem with trying to use "a bit of macro policy" to help bring about more economic growth, lower levels of unemployment, higher wages, better standards of living, and the like, isn't that such objectives would violate the laws of nature, and rip a hole in the fabric of the universe. It's that the objectives themselves would be too costly for capital--which, in turn, has the power to make whatever is too costly on its account doubly or trebly expensive for the rest of us. Since capital is the unmoved mover of the "advanced economies," the measure of all things, and all things eventually return unto capital, no responsible policymaker could act differently.
"To raise or not to raise, that is the question," the Financial Times observed in late January of last year. An existential concern, to be sure. Not since March 1989 had the Fed raised the short-term interest rates that the commercial banks pay on the overnight loans they make among themselves or draw at the so-called Discount window of the Federal Reserve Bank of New York. In fact, not since September 1992 had the Fed even changed one of its rates--the longest period it had ever gone without a change, up or down.
For the better part of 1993, a growing phalanx of Wall Street voices and media hacks had been accusing the Fed of being "behind the curve," one of the seven deadly sins in the judgment of the capital markets--the sin of being insufficiently vigilant in the fight to contain the working classes, whose propensity to spend whatever share of national income falls their way is what ultimately puts upward pressure on prices, much to the horror of anyone whose wealth is invested in financial instruments.
On January 31, 1994, Alan Greenspan appeared before the Joint Economic Committee of Congress. "The Federal Reserve, through its deliberately accommodative stance, has played a key role in the restructuring process," he said, alluding to the historically low real interest rates that his Fed had engineered for close to five years running as a sop to a commercial banking sector, reeling from a decade of bad debts, inadequate reserves, and the bursting of a financial bubble in real estate in the late 1980s. ("[A] gigantic and astonishingly successful exercise in rigging the markets in order to recapitalize an American banking system shattered by bad debts," as the Financial Times once described it, quite accurately.) "But it is important to emphasize that monetary policy must not overstay accommodation," Greenspan continued. "Maintaining the confidence of financial market participants has been crucial for sustaining the declines in inflation expectations and, hence, in long-term interest rates that have facilitated the balance sheet adjustments to date."
It was precisely because the Fed believed that it was beginning to lose the confidence of financial markets (e.g., long-term interest rates had already been driven up from 5.78 percent in mid-October 1993, their all-time low, to 6.30 percent by the start of February) that four days after Greenspan testified before Congress, the Fed finally pulled the trigger, raising the Fed funds rate by an insignificant quarter-point, from 3.0 percent to 3.25 percent.
"The decision was taken to move to a less accommodative stance in monetary policy in order to sustain and enhance the economic expansion," a press release from the Fed explained--a new precedent for the Fed, accustomed to saying nothing about its interest-rate decisions. "There is room in the yield curve for an increase in short-term rates without causing a change in long-term rates," the chairperson of the President's Council of Economic Advisers greeted the news. The hike "was good news for the world economy," the Financial Times proclaimed. It proves the Fed "has remained consistently focused on the underlying objective of monetary policy: to secure sustained growth with low and stable inflation and inflationary expectations."
Others disagreed. The Dow Jones industrial average plummeted, losing 96 points, or 2.4 percent in the hours after the Fed announced its move. Broader stock market indices also fell, not only in the United States, but in most of the OECD and APEC countries as well, where some bona fide routs have set in over the past 12 months, all linked to the shift in U.S. monetary policy. By the time Greenspan was ready to deliver the first of his semi-annual Humphrey-Hawkins testimonies before Congress on February 22, long-term U.S. interest rates had shot up from 6.31 percent to 6.62 percent, and rates around the world were rapidly following suit. Nine months later, when the Fed engineered its sixth hike of the year (very steep hikes of 0.75 percent in both the Fed funds and Discount rates--hikes that steep hadn't been seen since the Volcker Fed was busy engineering a recession way back in May of 1981), long-term U.S. rates had topped out close to 8.15 percent (some 30 percent higher than they were the previous February, and nearly 42 percent above their lows of October 1993), the Prime lending rate charged by the commercial banks had risen from 6.0 percent to 8.5 percent, and global bond markets had suffered their greatest percentage declines in value since 1929. Somewhat whimsically, Fortune magazine estimated that paper losses on U.S. government bonds alone totalled $600 billion through the first nine months of 1994, with global bond markets having lost a total of $1.5 trillion among them. The latter averaged out to around $263 in paper losses for every man, woman, and child on the planet. Spectacular sounding numbers, if nothing else. But what do they all add up to?
"We believe we are probably only at a mid-point of a 50-year process in what will be seen, in retrospect, as a fundamental transformation of how the world's economy works," the McKinsey Global Institute observed in The Global Capital Markets, a study of the changes taking place in the financial markets around the world, released last fall. "[W]e are in a transition period from markets that are still significantly local to a mature, fully integrated, global capital market."
From 1980 to 1992, the rate of growth of financial assets among the OECD countries outpaced the rate of growth of their real economies by better than two-to-one, McKinsey Global estimates. Daily bloodletting in the foreign exchange arena now exceeds trade in goods and services by an astounding fifty-to-one. In nominal terms (correcting for volatile fluctuations in market prices), the total stock of the world's financial assets reached $35 trillion in 1992, and could reach $83 trillion by the end of this decade ($53 trillion in constant 1992 dollars)--roughly three-times the projected GDPs of the OECD countries for the year 2000.
"Increasingly,...the vast stock of financial assets is beginning to act as if they were part of a single, integrated market that links together the foreign exchange markets, money markets, bond markets, and equity markets of all the nations who have removed their foreign exchange controls," the McKinsey study notes, with due attention being paid to the dramatic price declines the world's bond markets have suffered in 1994. Crucially, McKinsey believes that capital markets "will converge in the long-run to a single global risk/return relationship when currency-specific and all other risks are explicitly and consistently priced"--a nice way of saying that as financial capital scans the globe in search of its greatest comparative advantage, any government whose policies do not suborn the interests of its peoples to the interests of wayward capital will be judged harshly, and may not even get a second look. The bottomline is that we are witnesses to the development of a market for financial assets on a global scale that not only dwarfs the real economy, but that will continue to downgrade the weight that the real economy receives for policy-making purposes. As neoliberal policies spread and take hold; as telecommunications and computer technologies connect investors to arbitrage opportunities irrespective of border and locale; and as the practice of securitization deepens, submerging the real economy beneath a shadow market of derivatives and virtual capital; the market becomes more and more unforgiving. More and more intractable. Ruthless. Vengeful.
"We...see the potential for the global capital market to act as a powerful check on the tendency of governments in the developed world to issue debt to fund increased consumption in the form of entitlement programs," the study's authors predict. "By the straightforward act of making pursuit of these policies extraordinarily expensive [working through the medium of punitively high interest rates, that is], the market may be able to force the recognition and correction of fiscal policies that were, in any event, unsustainable in the long run."
What the slugs don't have, they cannot spend, the general theory says. And what the slugs cannot spend, cannot come back to haunt the global capital market as the specter of rising inflation expectations.
Which only goes to show that when Nixon once quipped, "We are all Keynesians now," he was wrong.
We are all central bankers now.