Federal Central Banks (Forum Press, 2018) is a unique study that critically examines the role and impact of central banks in federal and confederal political systems.
It conducts a detailed examination of the history, design and operation of central banking in the United States and in the European Union. The historical record from the US is that although the Federal Reserve (Fed) was established in 1913, it took until 1935 before it had been re-designed and removed from the destructive influence of the New York banks. Only at that point did it fulfil the requirements of what today is understood as an effective central bank. In the period starting in the 1980s the Fed fell under the influence of the New York banks again, accommodating every financial innovation and expansion of credit that was required by the private sector. In this latter period the influence of the US Treasury over the Fed was weakened under the doctrine of so-called ‘independence’.
There is a permanent contradiction between the centralizing features of banking and monetary policy and the political and economic expectations of pluralist federal democracy. This has come to the fore following the response of central banks to the global financial crisis. Credit easing transferred billions of dollars to large corporations and banks, and quantitative easing – for which there is no historical precedent in terms of scale – destroyed the nexus between saving and reward and between productive investment and return. The banks were saved at the cost of the economic welfare and savings of the majority of citizens.
This, unfortunately, is not a new situation. The Federal Reserve came into existence in 1913 because of agricultural depression, where farmers were placed in debt servitude by private banks. This recurred in 1933, but this time Franklin D. Roosevelt broke the stranglehold of the banks on the economy and reversed the recurring debt deflation problem. In this, he was ably helped by the Utah businessman Marriner Eccles who argued before Senate committees that depression could only be turned around by creating new lines of credit and via the stimulus of government expenditure. He r pointed out that ‘we can borrow from ourselves’ to get the economy working again and this was the rational solution. Eccles went on to reform the Fed as chairman in 1935.
Federal Central Banks assesses the establishment of the European Central Bank (ECB) and introduction of the Euro in the light of the Fed’s checkered history – one of evolution and regression. Design ideas are always context-dependent and reflect the prevailing economic doctrine and economic interests. Neoliberalism decreed in the 1990s that states should withdraw from monetary policy, leaving decisions to the money and financial markets with central banks simply offering guidance and nudges on interest rates. Or rather, that is what monetary policy became in the ‘noughties’. In fact, initially there was adherence to the inoperable Friedmanite doctrine of controlling the supply of money. This was totally reversed under the authority of Basel rules that allowed banks to issue unsustainable amounts of credit, which central banks were obliged, lacking previous tools or the will to use them, to accommodate. In a City forum a couple of years back I asked the governor of Iceland’s central bank why his nation’s banks were allowed to go on such a reckless credit binge. His answer was that it was not disallowed by Basel rules. The moral is pretty clear: Nations and their central banks, which have a responsibility to ensure the soundness of their national currency, a public good, should not offload responsibility to offshore agencies.
The ECB alongside every other OECD central bank were caught surprised and witless in the face of the global financial crisis, which erupted in 2008. So, no special blame should be accorded to the ECB, which was pretty much untested by crises – and it is only through crises that central banks acquire their full set of powers.
In 2008 the ECB was not a central bank. It had no powers to monetize state and private debt. This is the principle reason why central banks come into existence – to save the state finances in extremis – usually wars – and to save the banks from themselves (a story without end). The ECB was founded on the model of the Bundesbank, whose particular history was over-determined by the earlier Reichsbank, which had managed to destroy the savings of German burghers twice in the twentieth century. The Bundesbank was an over-rigid institution that only worked in the context of German democratic federalism and shared understandings between business, labour and government. It was highly inappropriate as the model for the new federal currency.
Germany is a fiscal state, a governmental democratic state, it has a Treasury/ Finance Ministry and, like all advanced economies, it has a regional policy within which fiscal transfers are made – and have been made ever since Bismarck’s 1871 Reich. The Deutsche Mark, post 1957, was secure within this framework. Not so the Euro. The Eurozone (EZ) within the EU has no Treasury or Finance Ministry, and the EU is not a federal state but a confederal association based on treaties. All EZ central banks moved a large proportion of their reserves to the ECB and Frankfurt, thereby losing their ability to fight a financial crisis; not only that, the ECB offered no corresponding gain in that respect, indeed, quite the opposite.
The other distinguishing defect of the Euro and the ECB, other than the economic perversity perpetrated universally by neoliberal doctrines, was the regional dimension. This really matters in continental-size political entities like the US and the EU. The conclusion of Federal Central Banks is that monetary-macroeconomics, as currently conceived, can do nothing to alleviate regional disparities. Monetary policy is undiscerning with regard to regions. In the UK we have the absurdity of Bank of England officials travelling around the country’s poorer regions – as if they were going to offer them a special rate of interest. Only fiscal policy can achieve some equity, and that is a political decision made by the Parliament and the Treasury.
Plains and valleys
The economic geography of the EU can largely be seen on the ground. The economic powerhouse is the North German plain – extended to Paris – with high prosperity corridors running down all the major river valleys into Austria and northern Italy. Everything else outside this core is periphery and will always be in deficit to the core. The periphery is good for selling consumer goods to, to holiday in, and a source of skilled and unskilled labour draining human capital to the core. The Euro and the Single Market recycled surplus profits and bank credit balances from the core to the periphery, too often into speculative and sometimes corrupt schemes. And, as is well known, this all went into reverse in 2008 as near-bankrupt northern European banks withdrew all that low interest credit. This created recession in the periphery and the collapse of taxation.
This was the same situation Roosevelt faced in 1933, and throughout that year he feared genuine rebellion from farmers and businessmen thrust into penury. In the 1907 depression (as well as in 1890s) the banks repossessed property, expropriating citizens on the basis of debt deflation. Roosevelt created federal institutions and a proper federal bank to counter the devastation, which bankers like Andrew Mellon were quite happy to see proceed (‘clearing the market’). Banks were reformed and given new lines of conditional credit, all within six months. Reconstruction agencies were founded to start government-funded investment programmes. Out of the latter came the federal bank deposit insurance scheme, which as J. K. Galbraith later commented, was probably the most important measure in turning the economy around – because the banks could, for the first time, be trusted. The government investment and work programmes were heavily weighted to the hardest-hit regions.
The Eurozone was incapable of achieving anything similar. It had no Treasury to re-allocate federal funds nor to issue federal bills and bonds to open new lines of credit. The Maastricht criteria that accompanied the Euro’s birth stipulated strict conditions on member states government debt (i.e. government budget deficit below 3% of GDP, and public debt to GDP ratio below 60%). As economic activity and taxation revenue plunged in the periphery, the deficit numbers went off the dashboard. Austerity was imposed by the northern-dominated Eurogroup as the price of pumping Euros into periphery countries.
These peacetime disasters can all be traced back to the immaturity of EZ institutions. There was no federal state to protect the federal currency. Roosevelt side-lined the Fed for several years, preferring to act directly. Getting the right institutional architecture requires time and a democratically mandated will.
Reform or die?
Federal Central Banks assesses the progress of EZ reform led by the undemocratic Eurogroup dominated by German led countries, first under Finance Minister Wolfgang Schäuble and now under Olaf Scholz. It suggests ways of moving forward despite German refusal. The federal vision of Schäuble is that all EZ members must replicate, as clones, German arrangements. This is an eighteenth century cameralist vision of administrative rules that ignores the fact that German export surpluses (and with that budget surpluses) cannot be replicated across the EU.
The book’s authors reckon that EZ success or failure will come to a head over Italy. It is not a periphery country (though of course it has its own periphery), therefore it cannot be treated as such. The “austerists” did not apply the same treatment to Rome as they did to Athens as the Great Financial Crisis ratcheted up. Italy is now to be governed by Euro-sceptic political parties.
Eurozone governance structures, centred on the Eurogroup, are dysfunctional and undemocratic and should be reformed. Also, federal level banking reforms need to go hand in hand with democratic accountability. This is a normative aspiration, which is pragmatically feasible. Equally, northern dominance could well ensure that existing north/south fractures widen.
Over all this still hangs the smell of the steaming pile of merde that was neoliberalism. Before the crisis, central banks were given the narrow task, independent of government, of maintaining price stability and the soundness of the financial system. In this, they failed spectacularly to the universal resentment of voters everywhere. Since then, central banks have regularised ‘unconventional monetary policy’, turning upside down previous orthodoxy. Today, central banks indirectly monetise state and corporate debt, determine long-term interest rates through massive bond buying programmes, deliberately seek to influence market allocation decisions, affect fiscal expenditures in selected area, and – despite defined legal remits – they have expanded their brief to take on effective governmental responsibility for growth, unemployment and productivity; and, last but not least, macroprudential regulation.
At the very least, we have a legitimacy problem, seen most acutely and dangerously in the rise of populist parties and opportunist politicians. There is no economic orthodoxy, only discretionary experimentation. There is no trust is the state’s ability to uphold citizen economic welfare and security. There is no social justice in coming out of the global financial crisis. Whatever the intellectual labour of the armies of economists and publicists now employed by central banks, there is no technical fix.
Max Weber, the first liberal economist to call for democratic federalism in the German Empire, once observed that modern capitalism would dissolve once nation states gave up competing aggressively between themselves. The spur to the administrative rationalization of new nation states, including the institutions of state exchequer and the bank to the state, was warfare. Neoliberalism is the ideological doctrine of capitalism under conditions of peace. It has ushered in not so much late capitalism as decadent capitalism.