Global Journal of Human Social Science, E: Economics, Volume 21 Issue 4

Volume XXI Issue IV Version I 10 ( E ) Global Journal of Human Social Science - Year 2021 © 2021 Global Journals Transforming Financialization and Inequality in a Post-Covid World situation, the Fed has not been inclined to raise short-term interest rates. This creates moral hazard (“heads I win, tails someone else loses”), which has fueled upward movements in asset prices that dates back to the stock market crash in 1987. (3) The Fed’s participation in the bailout of major banks and non-banks (e.g., AIG). When asked by Scott Pelley of 60 Minutes how the Fed financed the bailout of AIG the day before, was it tax money, Bernanke stated “No. It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account they have with the Fed.” This response provided powerful impetus for underwater homeowners and small businesses to ask why they were not recipients of Fed largess. (4) Implementation of Quantitative Easing policies that purchased securities from financial market participants while providing banks with interest- earning reserves. These purchases boosted asset prices and further widened the divide between the top 10% (and even more so, the top 1%) and the rest of U.S. households. Ideology overpowered reason during the 1980s and 1990s. Unfortunately, there was little understanding as to what differentiates banks and finance in general from other sectors of the economy. A commercial bank is granted the privilege of creating credit when it receives its bank charter. This privilege is unique to the banking system. When a bank creates credit, given double-entry bookkeeping, it also creates money. When a bank extends a loan of $10,000 to someone, it places a deposit in an equivalent amount in her account. Money is a public good. The belief that banks were capable of self-regulation implicitly assumed that banks would manage and monitor risk properly. This granted banks an enormous opportunity. Given that credit growth fuels asset price appreciation, as constraints were lifted, banks shifted away from support of productive activity toward asset-based speculation, as proprietary trading became an increasingly important source of profits. This repeated the experience in the years leading up to the Great Depression in a somewhat different format. The conservative economist and co-founder of the original Chicago School, Henry Simons, remarked that applying “free market” rules to finance is to commit a “category error.” The Fed chair, Marriner Eccles similarly testified before Congress that given the economic cycle, “laissez-faire in banking and the attainment of business stability are incompatible.” This is at least in part due to the presence of positive feedbacks; the concept of a “market clearing price” is foreign to financial markets, especially once constraints no longer exist. Finance can serve as a responsible servant to the productive economy, or it can instead become an irresponsible master. This was understood by the authors of the Banking Act of 1933, which was designed to address the issues that resulted in the Great Depression. The application of free market principles to banking and finance inevitably ends in a financial crisis, though positive feedbacks between credit growth and asset price appreciation can provide the “illusion of a “new economy,” as they did during the 1920s and again in the early 2000s. Keynes stated the situation well when he said “Financial markets can remain irrational for far longer than any of us can remain solvent”….though he should have added, especially given the Great Depression, “but not forever.” 12 The objective of this article is not to rehash the global financial crisis nor to bash the Federal Reserve. Mainstream economists as a profession (many of whom work at the Federal Reserve System) were lulled into a false sense of comfort by the emergence of a new set of economic (known as Dynamic Stochastic General Equilibrium or DSGE) models that posited stability. As the process ended in 2008, it became clear who the losers were, namely the bottom 90% of U.S. households (especially the bottom 50%), many of whom lost jobs and their homes, and the U.S. taxpayer. 13 Remarkably, these models did NOT incorporate money, finance, credit, or banks, based on the assumption that money is “neutral” and does not impact the real economy. 14 Since the early 1980s, the Fed has protected its independence within the Federal Government based on concern about political pressure that might result in inflationary monetary policy. Inflation since the 1980s has morphed from goods and services prices and become lodged in asset prices. However, asset-price inflation generates capital gains (realized or unrealized), which results in pressure being applied by market participants, etc. to perpetuate this process, via the Fed Put, etc. In my view, the Fed’s argument re independence has been eviscerated by recent developments. In fact, the Fed has never been more effective than when it was led by Marriner Eccles and worked closely with the U.S. Treasury Department during the Great Depression and World War II. As financialization unfolded, the Fed has become captive to the financial industry it is supposed to regulate (cognitive capture), as others have recognized. Little did they know…. 15 12 John Kenneth Galbraith referred to this pause as the “bezzle,” namely the period in which the winner enjoys the gains while the loser is not even aware of losses. 13 For more discussion of these models, see Balder (2018, 2020) and Keen (2011 and 2017). 14 I have discussed the misunderstandings of money by mainstream economics in numerous articles including Balder (2018 and 2020). MacLeay, et al (2014a and 2014b), Keen (2011 and 2017) and Werner (2016, 2014 and 2005) provide insights in support of this argument. 15 See Canova (2014, 2010).