Austerity mania, explained
Source Bill Lear
Date 11/09/21/12:39

ON HIS RADIO show, Behind The News of July 30, 2011, Doug Henwood
interviewed the economist Brad De Long about the current mania for
cutting deficits during our current catastrophic recession. Doug
puzzled why there seemed to be such a strong, and seemingly irrational
consensus in elite circles for austerity, and De Long also confessed
to being baffled. Below, I have what I think are the answers to this.
Here is an excerpt from the interview (any errors are mine):

Henwood: In watching the debate over the debt limit and
associated budget debates, I am scratching my head. [Does] the
mass embrace of austerity express some kind of material interest
on the part of the American elite, is it ideology, is it just
cynical political calculation? What sense does any of this make
to you?

De Long: You say you're scratching your head, and I'm scratching
my head considerably more. For one thing, it seems pretty clear
that what I've been teaching in my economic history courses for
thirty years is basically wrong. It was thirty years ago that
Barry Eichengreen taught me that we used to have a hard money
party, that we used to have a powerful political elite whose
wealth was overwhelmingly in either bonds with fixed nominal
coupon payments or in 99-year leases with fixed nominal rents, a
politically powerful class that had no interest in high
employment and a huge interest in stable or declining prices. And
this was the pre-World War I austerity lot, these were the people
who donated to [the] Mark Hannahs, candidate William McKinley,
these were the people who were opposed above all to the free
coinage of silver at 16 to 1, et-cetera, et-cetera. But they
don't vanish during World War I. When the printing presses opened
up and when rich people all over the globe realized that a
portfolio that relied upon holding just nominal debt was an
extremely risky one, and ever since World War I, everyone rich
and super-rich in the world, almost, has had a much more balanced
portfolio, has had their wealth in real-estate and stocks, as
well as in bonds. And so, all of a sudden the interest of the
super rich in depression, because depression brings deflation,
that that really vanished during World War I and has not
returned. You look at America's right-wing rich today, and they
aren't holding all of their wealth in Treasury bonds, waiting for
price declines to increase it.

Henwood: Eric Cantor is short Treasuries.

De Long: Yeah. If you say that the executive of the modern state
is a committee for managing the affairs of the ruling class, my
reaction would have to be "I wish". All up and down the income
ladder, everyone's overwhelming interest is in full employment,
and yet we're not seeing that playing out in the politics at all.

Henwood: Definitions may vary of full employment, but step back
to 1980, you said when Barry Eichengreen was saying these things,
that was towards the end of one of the worst periods to be a
bondholder in modern U.S. history, inflation was very high, and
Paul Volker was about to come in and put an end to all that. So,
what's changed between 1980 and 2011, if anything, that might
rejigger these interests?

De Long: Well, the rich have become a lot, lot richer in
proportion than they were in 1980, but again these lot, lot
richer have stock and real estate investments as well in addition
to and largely in place of bond investments. The rich had a
greater interest in recapitalizing the banking system, and that
was accomplished, but they still have a great interest in full
use of manufacturing capacity and by and large they have an even
greater interest in the recovery of real estate prices than the
middle class does. So, it doesn't seem to have been anything big
that has happened with respect to who owns what pieces of wealth
or what kinds of sectors benefit most from economic growth. So,
here I actually want to punt it over to sociologists or cultural
studies people of one sort or another. I at least listen to Ron
Paul and Rand Paul and it feels like ideas that ought to have
died a century ago, and ideas that made sense back when your
super-rich really were landlords who'd rented out all their land
on 99-year leases, or ex steel magnates who'd taken bonds as
their share of the buyout and had nothing else. It made sense
back then to talk about the importance of the gold standard and
the importance of avoiding any inflation as job one, and yet it
still makes no material sense to me right now.

---Doug Henwood, Behind the News, July 30, 2011

When elites act in seemingly irrational ways, I knew the first thing
to examine would be economic structure and how it affects policy
prescriptions. The person most capable of explaining this is Thomas
Ferguson, a professor of political science, who by coincidence had just
written about this very topic with Robert Johnson when I queried him.

According to Ferguson, the answer to the question of why "so many
leaders in business and politics [have] suddenly become fixated on
the new twin terrors of deficits and inflation" is pretty
straightforward, and involves an ironic dab of good old fashion
crowding out theory.

To start with, the growth of the financial sector needs to be

Over the past thirty years, in country after country, the very
largest financial institutions became gigantic in size.

There are several aspects to this that need to be made clear. First,
the financial sector has indeed swelled in size: by 2007, it accounted
for 47% of U.S. corporate profits. Second, it has become more
concentrated, dominated by fewer massive, oligopolistic firms. Third,
it has become riskier --- debt load of the financial sector increased
from 22 to 117 percent of GDP between 1981 and 2008. ["Business As
Usual: The Next Wall Street Collapse", Jonathan Kirshner, Boston
Review, January/February 2011,]

These institutions are not only "too big to fail", but "too big to
bail", as rescuing the financial system often requires massive shares
of national incomes that might otherwise be used to, among other
things, pay schoolteachers, build bridges, and feed hungry children.

Only now are the implications of this towering fact coming to be
appreciated outside financial markets. But careful studies of
bank stock prices show that markets grasped the key point much
earlier: Beginning in the summer of 2007, fears multiplied that
one or more big banks might fail. Share values of the largest
banks fluctuated with perceptions that other emergency claims on
national resources might empty national treasuries of the funds
required to bail out the giants. That is, whereas financial
bailouts (on favorable terms to the banks, which most were) had
positive effects on bank stock prices, wider deficit spending
packages drove big bank stocks down relative to the market as a
whole (Demirguc-Kunt and Huizinga 2010). Here was a form of
"crowding out" beyond the imagination of both Keynesians and free
market enthusiasts: The need to preserve financial resources for
a contingent fund that would be available for further bailouts
was killing the Keynesian revolution in economic policy-making.

So, in short, anything that might diminish the ability of a government
to bail out the financial system, say by spending money to push up
employment, will be fought tooth and nail by these gigantic
institutions. Thus finance capital, in a sort of neofeudal form,
exacts a terrible rent on the rest of society.

As of December 2010, almost 15 million people in the United
States were unemployed. Millions more were either underemployed
or became so discouraged that they stopped looking for work and
thus are no longer counted among the "unemployed." A whole
generation of young people is being reduced to begging for
chances to work free in "internships" in the hope of getting a
foot inside doors that are otherwise slammed shut. Crusades to
cut Social Security threaten to remove a basic underpinning of
the living standards of millions of people who first lost their
savings in the financial crash and then paid with their taxes to
bail out the financial system. And the Obama administration's
reluctance to extend aid to states means further deadly rounds of
state cuts are inevitable. Just as in the Great Depression, these
will neutralize federal efforts to stimulate the economy. They
will also lay waste to enormous amounts of public capital built
up over many years by the states, especially in their educational

---Thomas Ferguson and Robert Johnson, "A World Upside Down?
Deficit Fantasies in the Great Recession", International Journal
of Political Economy, vol. 40, no. 1, Spring 2011, pp. 3-47.

The rest of Ferguson and Johnson's article is well worth reading, in
which they: refute claims by Reinhart and Rogoff, and the IMF, that
rising debt-to-GDP ratios stifle national economies (notably, Britain
industrialized with massive amounts of debt-to-GDP ratios for decade
upon decade); deflate Alberto Alesina and colleagues' claims that
deficit cuts somehow stimulate demand; lay out grounds for skepticism
of recent CBO studies on debt and economic growth; point out in a
series of "whale watch" vignettes the costs to our economy from
oligopolies in health care and defense industries, and the possibility
of another financial crisis.

I guess in some ways, the current austerity mania derives from a
need for a reserve army of capital to pay for future financial
disasters. What a world.

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