In 2008 the United States unleashed the global financial crisis which nearly upended the world economy and came to be known as the Great Recession. The problems that created it weren’t solved but swept under the carpet. Over the past ten years, new bubbles have been inflating in place of the ones that burst back then. Now, America is about to visit another massive crisis upon the world. It will be the continuation of the first one in the same way that the two world wars of the first half of the 20th century should be seen as a single conflict with a long truce in-between.
Last week, when Jerome Powell, chairman of the U.S. Federal Reserve, testified before Congress, Alexandria Ocasio-Cortez, a progressive member of Congress from New York, asked him about the lowest sustainable rate of unemployment – i.e., how low unemployment can go before it triggers inflation.
In mainstream economics, unemployment and inflation are related through the Phillips curve, which requires inflation to rise as the jobless rate goes down. In recent years the relationship seems to have broken down. As the unemployment rate fell, reaching a 50-year low, inflation declined as well. So the Fed kept reducing the “safe” rate of unemployment, and Powell claimed that joblessness could go even lower before the Fed begins to worry about inflation.
Powell’s response was fudged. It had to be, because in truth the traditional scholarly framework of economics, perfected during the early decades after World War II, has fallen apart. For all the learned mambo-jumbo Powell mouthed during his congressional testimony, the Fed in its management of the economy is groping its way in the dark. The economic situation defies economic orthodoxy – and a more accurate framework to understand what is happening is yet to be developed.
And, without understanding why things are working the way they are it is impossible to develop effective policies. Donald Trump, who feels that the strong US economy will get him re-elected in 2020, has been demanding that Powell cut US interest rates. The rudderless Fed looks likely to comply at the end of July — and to ease once more before the end of the year.
Except for appearing to cave in to Trump’s unprecedented demands — as the U.S. political establishment has done repeatedly since his election, anyway — Powell is treading upon familiar ground. Loose money — and loose dollars above all — have shaped the global economy and defined the development of society over the past four decades.
The 1970s and the early 1980s were defined by the struggle against inflation. But inflation, which economists believed was a universal phenomenon connected to paper money, turned out to be associated with the more egalitarian and tightly regulated economy of the time. Supply of goods and services was restricted by regulation while workers received compensation which exceeded their productivity. More money chasing a set quantity of goods led to price increases.
In retrospect it is clear that in the 1980s inflation was brought under control not so much by draconian interest rates as by social change. Alan Greenspan, appointed Fed chairman by Reagan in the mid-1980s, gradually realized that he could keep flooding the economy with cheap money without the fear of triggering inflation.
Cheap dollars may not have engendered social change but they certainly greased the slides. Thanks to low interest rates the high-tech revolution was greatly accelerated. New technology boosted productivity and put further downward pressure on inflation.
Similarly, plentiful liquidity — and plentiful investment funds — didn’t cause but sped up the emergence of China as a cheap global manufacturing hub. Technological progress and information technology allowed companies to build up production capacities quickly and to produce everywhere around the world, creating highly efficient supply chains that allowed them to keep prices low.
Unlike the previous era, workers didn’t get the monetary benefits of higher productivity. They got cheaper goods but the profits went to those who controlled technology or could take advantage of the cheap money that the Fed — along with other central banks — was pouring into the global financial system.
Thus, progressively low interest rates have also been responsible for the rise of the international super-rich class.
The only problem with this type of monetary policy is that it devalues money and creates financial bubbles. In the post-Depression period that ended in the 1980s, central bankers would raise the price of money every time financial bubbles were in danger of developing. William McChesney Martin, post-World War II Fed chairman, famously said that the central bank’s job is to take away the punch bowl just as the party gets going.
The new thinking at the Fed and other central banks has been to spike the punch with more alcohol to make sure the party doesn’t end. This has created progressively more dangerous bubbles. The crisis of the early 1990s was moderate, the dot.com bust in the early 2000s was more severe and the 2008 subprime mortgage crisis, followed by the euro-zone debt crisis, was a major economic, social and political debacle.
Each time the crisis whose origins had been easy money was addressed by throwing even more easy money at them. Trillions of dollars worth of liquidity have been poured into the global financial system since 2008.
A new depression has been avoided and the world economy has recovered — but at a significant cost. A tremendous social divide has opened up between “the elites” and “the people.”
For the elites money has been devalued, turning one dollar of ca. 1975 into an equivalent of one cent today.
We now have three distinct economies with three distinct growth, unemployment and inflation rates: one for the super-wealthy, one for the elites and one for the people. All those economies look very different, and whether you believe the economy is working depends on which one of the three economies you inhabit.
The anger, resentment and economic fears of those who have been left behind gave rise in recent years to a wave of political populism, propelling right-wing parties to power.
In the US and the U.K., where those economic trends have been most pronounced, they have led to a bona fide political earthquake.
Now the Fed is moving to ease its monetary policy once more. This comes at the height of the longest economic expansion in US history, when unemployment is at a historic low. Loose monetary policy complements extremely loose fiscal policy: at a time of full employment and record corporate profits the Federal government is running trillion-dollar deficits. Meanwhile, financial markets — both bonds and stocks — are in a liquidity-driven bubble stage.
When such extreme measures are needed to prolong the life of existing bubbles it is a sign that the endgame is at hand. We don’t know when it will come, what will trigger the reckoning and what form it will take. The only thing that can be said, in the words of another prominent economist of the post-World War II era, things that can’t go on forever usually don’t.
