“The End of (Monetary) History”

Erinç Yeldan

As we are about to wrap up 2014, it may prove worthwhile to celebrate the 70th anniversary of one of the most innovative and exciting episodes of homo economicus: The Bretton Woods Monetary Conference. Convened in 1944 at the Mount Washington Hotel in New Hampshire, the conference established the World Bank and the IMF (later referred to as the “Bretton Woods Institutions”) and set the gold standard at $35.00 an ounce with fixed rates of exchange to the U.S. dollar.

Based on John Maynard Keynes’s famous dictum, “let finance be a national matter,” and on the productivity advances of Fordist technology and institutional structures, the global economy expanded at a fast rate over the postwar era, from 1950 to the mid-1970s. Per capita global output increased by 2.9% per year over this period, which later came to be referred to as the “Golden Age of capitalism.” (In contrast, the average rate of per capita growth over the whole century has been estimated at 1.6%.)

The conditions that created the Golden Age were exhausted by the late 1960s, however, as industrial profit rates started to decline in the United States and continental Europe due to increased competition, particularly from the Asian “tigers” or “dragons” (Republic of Korea, Taiwan, Hong Kong, and Singapore). In the meantime, Western banks were severely constrained in their ability to recycle the massive petro-dollar funds and the domestic savings of the newly emerging baby-boomer generation. Trumpets for the “end financial repression” intensified with the so-called McKinnon-Shaw-Fama hypotheses of financial deregulation and efficient markets. A global process of financialization was commenced, lifting its logic of short-termism, liquidity, flexibility, and immense capital mobility over objectives of long-term industrialization, sustainable development, and poverty alleviation with social-welfare driven states.

A number of researchers (e.g., Acemoglu 2009; Stiglitz 2011; Epstein 2005) and a series of reports set from UNCTAD had long warned against the dangers of excessive financialization and deregulation.

Under the new financialized capitalism, loanable funds are increasingly diverted away from the real sphere of the economic activity and towards speculative finance. The global economy has grown too slowly and allocated too small a portion of its scarce savings into physical fixed investments that would enhance employment and generate incomes for the working poor. An ever-increasing portion of global profits are now generated from speculative finance, rather than productive activities. According to ILO’s estimates in the World of Labor Reports, financial profits currently constitute almost 50% of aggregate profits. This ratio was only a quarter in the early 1980s. As accumulation patterns diverged away from industry towards speculative finance, employment faltered and the global economy entered a phase of “casino capitalism” with international productivity gaps being maintained due to structurally persistent differences in physical infrastructure and human capital.

We know where this story led. As the speculative bubbles of finance erupted in 2008, a real-sector crisis developed that would lead to what has been called the Great Recession. Output declined in 2009, for the world as a whole, for the first time since the 1930 crash. Some 20 million people were added to the reserve army of the unemployed, bringing the total to above 200 million, or 7% of the global labor force.

The main policy intervention in response to the crisis—monetary expansion—was again based on the conventional recipes of the Bretton Woods system. Under a policy referred to for public relations reasons by the esoteric name of “quantitative easing,” the U.S. Federal Reserve (the “Fed”) amassed a total of $3 trillion worth of assets from the finance markets. This equaled roughly 20% of U.S. GDP. In turn, interest rates fell all around the globe to virtually zero; yet unemployment barely fell to the pre-recession levels despite the fact that labor-force participation rate was reduced sharply to its 1970s level

These large monetary interventions barely made a dent in the real sector, with GDP in U.S. and elsewhere remaining stagnant throughout the Great Recession. The figure below summarizes these developments.

Source: US. Bureau of Economic Analysis

The figure illustrates, vividly, the most decisive example of the “end of history”—monetary history, that is. The dramatic expansion of the monetary base and the equally dramatic collapse of interest rates are clear. Everything works in textbook fashion up to that point. But the effect in terms of real output is overwhelmed by the conditions of the Great Recession. In the absence of an effective real rise of investment demand, the expansion of monetary base and the collapse of the interest rates have had a negligible effect on GDP. That means that the instruments of monetary policy are virtually powerless.

What a nightmare for a central banker!

References

Acemoglu, D. (2009) “The Crisis of 2008: Structural Lessons for and from Economics” CEPR Policy Insight No 28, London: CEPR

Epstein, G. (ed) (2005) Financialization and the World Economy, Edward Elgar Press.

Stiglitz, J. (2011) “Rethinking Macroeconomics: What failed, and how the repair it” Journal of European Economic Association 9(4): 591-645.

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