Photo: AP
Photo: AP

Opinion | The Federal Reserve Board and socialism in America

It will be ironic if an institution created by bankers ends up midwifing the birth of socialism

Central banks in the US, Europe, UK and India have turned around remarkably. Although the biggest turnaround in the monetary policy stance has been in the US, it has been no less dramatic elsewhere. The UK, too, was poised to raise interest rates this year but now it has warned of dire consequences to growth from a hard Brexit and has retreated. In Europe, the travails of the German economy, economic recession in Italy and a slowdown in France are making the European Central Bank rethink its tightening too. One year ago, it was synchronized global expansion. Now, it is synchronized global slowdown. The fragility of the global economy has not only raised questions on the efficacy of the drastic monetary policy actions that followed the global crisis of 2008 but it has also thrown up big challenges to governments going forward. Unpopular actions that hurt elite and rich interests are unavoidable.

First, the slowdown should not surprise anyone. Globally, debt-induced economic growth has brought forward growth for quite some time. But, as is the case with China, so is the case with the world economy. The more debt one piles up, the less effective the incremental dollar of debt in stoking animal spirits where it matters—in the real economy.

In other words, mean reversion in long-run economic growth after the unsustainably long debt-fuelled expansion of recent decades is inevitable. But politicians and technocrats are having none of it. They want to keep the show going. It is done in the name of the workers. But it will end up alienating all but the moneyed class.

In the US, the Federal Reserve Bank of Richmond has its own Hornstein-Kudlyak-Lange (HKL) Non-Employment Index that attempts to capture the underlying trends in the labour market which are masked by the headline unemployment rate.

That rate was 7.7% in December 2018, even lower than what it was in the second half of 1999 when the US economy was firing on all cylinders. The HKL index, including those who are working part-time but are available for and willing to work full-time, is 8.6%. In June 1999, when Alan Greenspan began raising interest rates, the rate was 8.7%. But now the Federal Reserve Board has signalled that it is done. One explanation is that the wage inflation rate in the US was higher then (3.7%) than it is now (3.4%). But therein lies the paradox. The reluctance to continue to normalize monetary policy will actually end up hurting workers more.

After a near 10-year-long expansion and a very tight labour market, the rate of growth in the average hourly earnings of production and non-supervisory workers is only 3.4%. Therefore, the woes of the working class have their origins elsewhere.

Up to the onset of the 1980s, wages were rising and the successive peaks were higher. Workers did (too) well. Consumer price inflation rose but inequality was not an issue then nor were banking crises. But now with seemingly long expansions and low inflation rates, the working class is suffering from the return of market concentration and oligopolistic tendencies that boost profit but not wages, technological developments that heighten job insecurity, monetary policy that targets inflation in wages but not in asset prices and leverage-enabled growth that favours those with assets, as only they can avail of loans with cheap financing. These factors are keeping a lid on wage growth despite a record-long economic expansion.

The Federal Reserve halting its tightening cycle vindicates the proponents of the secular stagnation hypothesis and that keeping asset bubbles going is the only way to maintain economic growth. But that would compound all the above problems. It may keep the economy growing at a modest pace for a few more quarters, if at all. But it would more likely contribute to much higher asset returns for asset prices dance better to the tune of liquidity than to the tune of profits. In the first quarter of this year, S&P 500 profits will decline year-on-year but yet the S&P 500 index had its best January in three decades. As the asset price cycle extends and the bubble expands, economic inequality will widen. But, at least in absolute terms, income growth will be positive.

However, that will be short-lived when the asset bubble bursts as it inevitably will and the economic expansion gives way to a recession. Asset prices will crash no doubt but even the anaemic wage growth will cease as the unemployment rate will spike again. That could light the fuse under the fraying social cohesion in the US and elsewhere in Europe.

One can see this in the very leftward lurch in the policy platforms adopted by presidential hopefuls in the Democratic Party. The about-turn by the Federal Reserve will help strengthen such tendencies. May be, in that sense, the Federal Reserve is working to tame the excesses of capitalism! Nonetheless, it will be poetic justice if an institution created by bankers to protect their interests ends up midwifing the birth of socialism in America.

V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University). These are his personal views.