Writing in the late 1930s, in the midst of an economic collapse occasioned in part by the complete breakdown of the financial system, John Maynard Keynes: wrote: “Speculators may do no harm as a bubble on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”
Along similar lines, the historian Karl Polanyi distinguished between societies that use markets as one tool to produce and distribute goods and market societies, where the very foundations of society, land, labor, and money itself, are treated as speculative commodities to be bought and sold on largely unregulated markets.
Deep depression coupled with the pointed warnings of such scholars as Keynes and Polanyi served as a guide to financial policy for an entire generation following World War II. Were both alive today, they would be appalled but hardly surprised to see the damage that deregulation of financial markets has inflicted on the United States and the European Union.
How did this happen? How is it that the lessons of the Thirties were so completely forgotten? The politics and economics of the Seventies and early Eighties started the process, but academic theory played and continues to play a major role.
One could begin a story of the academic role at many points, but one surprising point of entry is a textbook that many of us forty or older probably used for those economics 101 courses. Paul Samuelson is famous for purportedly reconciling the classical notions of supply and demand in individual product markets with the need for government created demand in the overall (macro) market. Most of the time supply and demand in the overall market could be brought into equilibrium through adjustment of the short- term interest rates. But in the unusual event of a large fall in demand, interest rate changes would not be enough and government could and should inject demand directly into the economy. But even in these instances the amount of “stimulus” needed could be specified ahead of time and the patient could be easily brought back to normal.
Based on such assumptions, economists went on to claim that one could determine a smooth and predictable tradeoff between inflation and unemployment and merely pick the point on the curve that best met popular expectations.
Confidence that a bit of interest rate manipulation or an occasional dose of government spending during acute slumps would maintain a stable and beneficial tradeoff became hard to maintain in the seventies. The nation experienced periods of high inflation and joblessness, so called stagflation.
In retrospect the challenge of stagflation could have been an occasion to challenge the micro side of Samuelson’s synthesis, the faith that prices in even those markets for goods and services are best understood in terms of supply and demand reaching predictable equilibrium in competitive markets. Though some left and liberal economists of the period did emphasize pricing power in concentrated industries, the OPEC oligopoly, turmoil and speculative excesses in currency markets, and the elimination of world grain reserves as at least as big a cause of stagflation, orthodox economics had established a foothold even with the liberal cannon as represented by Samuelson. Alternative voices were written off as extremist, Marxist or worse.
Many business leaders were ready to pile on. Though enjoying government subsidies, some had long chafed under government and union restraints. They joined the chorus of free market defenders and mounted a counterattack on the moderately interventionist side of Samuelson’s synthesis. Wage standards, trucking and airline regulations, union protections all became targets. Corporate and individual income tax reductions were added to this so- called supply side revolution.
This legislative agenda started to undermine the post WWII egalitarian thrust of US capitalism. But the task was far from complete. Finance had been barely heard from. It is probably hard for those growing up in the post Clinton world to hear that once upon a time banking was considered a boring occupation. One used to speak of bankers’ hours — at work by 9, lunch at noon, on the golf course by 3.
These boring bankers performed an important function. They took deposits from savers and loaned some portion of these to would- be homebuyers and business enterprises. Other banks, so- called investment banks, used their capital to engage in more risky activities, including underwriting mergers and acquisitions, IPOs and stock market investments. The former banks were insured, another result of lessons learned from thirties history, when even well run depository institutions faced runs. But one price depository institutions paid for insurance was acceptance of regulation and regular inspection by the FDIC. Not only was the quality of assets monitored but also the Glass-Steagall Act forbade their participation in investment banking activities.
The repeal of Glass Steagall is often taken as a watershed moment in our economic history. Correct as that judgment is, the repeal of this New Deal statute was symptomatic both of longer term problems in liberal regulation of banks and of further developments in academic discourse, These will be the subject of my next column.
John Buell lives in Southwest Harbor, Maine and writes on labor and environmental issues. His books include "Politics, Religion, and Culture in an Anxious Age" (Palgrave MacMillan, 2011). Email firstname.lastname@example.org.
From The Progressive Populist, December 15, 2013
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