A book worth rereading, or even dipping into, is Galbraith's A Journey Through Economic Time, which recounts his personal view of the development of the liberal system. He tidies up a few things, but it is still a good reminder that people often stumble through the dark, and systems are emergent - when a feedback loop is created, it produces a spark of activity, and people follow that. Ordinary individuals often drive policy, and government is often like the cosmic ray that sets off a lightning bolt - the potential energy had to be there.
The Keynesian Economy has long since fallen, but left behind a large circulatory system which was picked up by the Friedman-Mundell economy. The difference is the the Keynesian economy was largely a closed circulation, and generated net savings, while the Friedman-Mundell economy responded to the challenge of energy inflation by creating a mefo-financed asset bubble.
FDR came to power with gut level insights into politics and economics, and the willingness to listen to people who knew more than he did. The system that the New Deal - which was built by vast array of people from top to bottom of the society - has stood in its essence. It has survived the fumbling in the dark of Democrats and Republicans, and is even managing to prove resiliant in the face of a full frontal attack by those who want to harness to produce a "Project for a Never-ending American Cluster-fuck".
However, there are severe stresses on this system, both in the US and around the world. More over, there are limits to this system, it has not always been as fair and as prosperous for all as it was for some. It was reliant on a prodigal use of resources, and, to some extent, a constant external pressure to produce the kind of internal unity and political responsibility that it required.
There is a new liberal system coming, one which, while based on many ideas of the old, has a new basis and must answer new problems.
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Let's first look at the full form of the Keynesian Economy above.
Government used three import ways of controlling inflation:
- Progressive Income taxes reduced ground rents
- Payroll taxes controlled consumer inflation
- Economies of scale controlled manufacturing inflation
The procedes from these became the budget, and a relatively balanced budget was a sign that the government was reducing inflation by as much as it was spending on government demand. This flow of funds was then used to drive two kinds of redistribution of purchasing power: horizontally through out the country, and vertically to reduce poverty. Each of these fed back into the inflation loop. What this means is that by giving more people purchasing power, there was broader demand, and therefore a push to economies of scale, and by reducing poverty, there was more labor, thus allowing economies of production.
There was, however, a large hole in the Keynesian economy, namely that it required large access to raw materials. In order to secure these, it engaged in interventions in developing nations to obtain these materials, often setting up regimes that it would not have otherwise tolerated. While this was done, and even thought of as "fighting international Soviet Communism", it had the unwelcome, and ultimately destabilizing, effect of putting the control of the economy in the hands of states such as Saudi Arabia.
This created a domino effect - with the reduction in social surplus, the political will for poverty reduction disappeared. Those working didn't want an increase in the size of the labor pool of their direct competitors. There was also a destabilization of the support for taxation - because the government, even though the budget was not much more out of balance than before, was not reducing inflation as much as it was generating demand. Instead, it was seen, to some extent correctly, as the government using seinurage as an tax on holding currency or assets. There was a revolt of the creditor and investor class, as well as those who owned land, also taxed by high inflation rates.
With these props gone - support for vertical demand spreading, support for progressive taxation, and the ability to lower materials costs through internationalism - the Keynesian economy collapsed.
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The replacement economy is the Friedman-Mundell economy. Instead of controlling inflation through fiscal means - taxation - the "dubious magic of monetary policy" was used. That is the Friedman part. Instead of controlling input inflation through economies of scale, globalization - that is having other develop a broadened labor pool in order to sell to the US, and loan back to the US to protect profits from local instability - was used.
The Friedman Mundell economy is the Keynesian economy with several of the polarities reversed. Instead of spreading of wealth, there is concentration of wealth. Instead of the US economy being a net creditor, it is a net borrower. Instead of building up free societies, or societies which liberalize in order to develop their economies, it increases the strength of unfree societies engaged in neo-mercantilist policies. Instead of using savings to drive expansion, it uses borrowing, instead of wages to drive demand, it uses the wealth effect.
The political support for this system comes, of course, from those benefiting, or thinking they are benefiting, from asset inflation. That is to say, the political constituencies that Adam Smith warned about in 1776: those who would seek to control prices. We now understand that information assymetries show up as persistent unemployment, and indeed there has been a thirty year climb of structural unemployment in Europe and the US. In 1968 unemployment what is now called "The G-8" was purely nominal, now measured as labor slack, it is nearly double digits, even near the peak of the economic cycle.
The ultimate stress on the Friedman-Mundell economy is that the developed nations are net borrowers, not to developing nations, which would lead, eventually, to development flowing back to the developing nations as they used their credit to buy equipment and intellectual capital - but to elites, particularly elites of unfree nations. This sets off a red queen's race - asset inflation is used to stay ahead of asset growth by unfree elites, which in turn becomes profits in the hands of unfree elites, which sets off more pressure for asset inflation.
The solution to this? Capitalism.
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Yes, capitalism, because despite the cries of both socialists and neo-mercantilists, capital is what is getting screwed here, both personal, social and corporate. The return on capital is set by the return on unfree capital - either energy extraction, or labor arbitrage. Unfree returns, just as in the 1930's, can drive out free returns. In the 1930's Nazi German controlled wages, borrowed internally for development, and looted its own citizens. Investment flowed in from other nations, hindering the ending of the Great Depression in the United States, England and France. Sweden, because it had something to sell to Nazi Germany, could finance its way out of the Depression exactly as neo-classical economics predicts. The other nations received a second shock to their economies, as investment that should have produced a full recovery fled seeking unfree returns.
While those benefiting from asset inflation call themselves capitalists, in fact the value of their assets is strictly the cost of substituion. Microsoft is worth, roughly, the cost in labor of everyone having to move off of MS products. The profits from capital in China are virtually zero, which is why their stock market is in such crummy shape. Think about the world's best performing economy having the world's worst performing stock market.
But if capital in developed countries is doing poorly under this neo-mercantilist regime, in developing free countries, it is being anhilated. This is why many of them are turning to socialism, because the individual profit motive is to invest in developed world asset inflation - rent in the US - rather than capital in their own countries. The key to capitalism is always and everywhere to make it so that the return on rent is lower than the return on capital. If not, people bid up the price of rent, and "capital" is only developed as a way of creating and fighting over "property" rights.
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The F-M economy was predicated on the belief that, eventually, somewhere down the road, there would be a massive cut in federal spending to match the massive drop in revenues. However, this has not happened. While the people there at the creation of the F-M economy did not intend it, borrowing is a permanent part of their economic structure.
This is for several reasons, however the most important one is that they believed their own hype about how investment demand - pumped up by slashing tax rates - would produce investment supply. If it had, the P/E ratio of the major world stock markets would be at historical averages, instead, they have been higher than historical averages - in fact at levels that usually signal a crash - for some time.
What this means is that the F-M economy did not deal with the problem of the Keynesian economy - it merely started bribing the unfree elites with more and more control over the developed world economy. The governing reactionary order has realized that the debt can never be paid off, and is seeking to modify the F-M economy so that it never needs to be paid off. This is why the US is seeking imperium in the middle east, and why Barros' REH is a hot belief among the right wing. The first one says we will pay off the debt by forcing the Arabs to buy from us at gun point, the second says that this threat will force them to keep lending to us while we do it.
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Capitalism, as noted, is the solution. And a neo-Keynesian global order is the means to do it. Reducing global poverty will dramatically increase the world's labor pool, and allow developing free nations to compete with unfree labor supply nations. The other component, however, is replacing the energy flow currently coming from unfree nations. There are other reasons to do this: long term global warming will destroy any economy based on hydrocarbons, and long term there is depletion of hydrocarbon supplies. These long term forces are in addition to the short term incentive to stop sending money to people who fund suicide bombers. This should, in a sane world, be a no brainer.
Thus the two important tasks - ending global poverty and economy of scale energy - have already been recognized. The means to economy of scale energy is also a straightforward Keynesian process. In fact, energy was a component, from the beginning, of Roosevelt's economic thinking, even while he was governor of New York. He realized that power was a rent, and that rents had to be either taxed or in public control. He chose public control, which has overall been the best solution.
Just as with the original Keynesian economy, reduction in poverty isn't a net cost - it reduces inflationary pressures, and not coincidentally the costs of jailing or shooting the poor - and is therefore a net win. Poor people are expensive.
The key problem is taxing unfree societies. The last time the developed Democracies got themselves into this bind it took a very expensive world war to break the dependency. Fortunately for the present, the legal tools that that period created are still available. The withdrawal from unfree profits, asset inflation and labor arbitrage will be painful, but it will only get more painful as time goes on. Presently the West has the military power to enforce such a re-ordering. The last time, in th 1930's, it failed to do so, but instead did business with unfree states all the way up to the bitter end.
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While it would be Keynes who would provide the paradigm that would lead to the old liberal economy, it would be Winston Churchill and Franklin Delano Roosevelt who, without prompting from others, conceived of its political execution. Theory often explained what and how they were supposed to act. They were responsible for many of its both postive and negative features. The decision to follow "bigger is better" was FDRs - there were "small is beautiful" roads open, though they would not have provided America with the war machine it would later need to defeat the axis. Churchill was the man who enforced the map of the Middle East, and based the British navy on petroleum. He saw the possibilities of the mechanized economy - and its attendent war supply system - before others in the developed world.
The two men, more than others, were responsible for the marrying of planned military supply, with corporate-government economy, and socialized system of national income. Others were more responsible for individual pieces, but it is they who found the way to synthesize the three and maintain a functioning balance. It was thus the Anglo-American model which dominated the late 20th century, while other nations fit within, making different marginal choices about having a greater social surplus in return for lower military expenditures.
The Friedman-Mundell economy was, to no small extent, the creation of a tripart alliance of Margaret Thatcher, Ronald Reagan and Helmut Kohl. They bought with it a generation of conservative, and then reactionary government, and the concentration of power in the corporate executive class. However, the system does not, and will not, sustain itself. Both because it never really solved the previous Keynesian problem, and because it has its own internal contradiction - it is accelerating the development of states hostile to democracy, and creating increasing conditions of chaos within both potentially liberal and democratic states - small letters - as well as feeding the rise of a new wave of unfree movements around the world.
It will take visionary leadership to again impose a new economic and poliitical vision, and it will take a populace that has turned away from the old path. This will not happen until there is a major crisis and either a meltdown of asset inflation - which is the problem everyone worries about - an explosion of energy inflation - which is the problem everyone is beginning to worry about - or a dramatic exposure of the weakness of the United States by a power grab of unfree societies - which is the probable end result. Not a stock market crash, nor $200/barrel oil, but, instead, a moment where there is dollar-yuan parity, and nations fall into the Chinese orbit and begin adapting themselves to the Chinese model. It has already started with Taiwan, which is enticing the Chinese with promises of a huge undeveloped gas field, and the technology it needs to become a first world nation.
The direct solution would be to end exemption for foreign income taxed elsewhere, and simultaneously having the G-8 impose a currency conversion tax of 2%. This would reduce the liquidity of currency movement, which could be neutralized by having the Dollar, Yen, Pound, Euro, and minor dollars (Canada, Australia) - agree to a fixed currency. It would have to be done swiftly to prevent exploitation. It would probably be done at the bottom of an already bad economic down turn, since the costs would be high.
This would radically limit capital movement, and would reduce the effectiveness of monetary policy. There would be a period of micro-economic management. Usually these powers are associated with a war. The US, and NATO, are in fact currently involved in a declared global war on terrorism, and have been avoiding dealing with wartime inflation. The costs of this failure are now coming due. There would then be internal overhauls of the income tax systems of the various major nations - with Europe ending the employment tax as a way of funding health care, and the US ending its current concessionary tax rates on the wealthy. A controlled devaluation - read inflationary - period would reduce the value of nominal debt to half of its current value.
Again this level of high inflation is normally associated with the end of a war time period - about 1/3 of the "deficit reduction" after the Second World War was, in fact, merely allowing inflation to take its toll on bond holders.
The present problem is that the economic elites - who required having Pearl Harbor bombed before they would realize that they could not live in Democracy while profiting from Autocracy - will not stand for this until there is a cataclysmic event. The question is whether we need an actual global conflict - one is coming in approximately 15 years time when China will seek to secure Middle East oil supplies - or whether we will make the transition first, accepting the cost. The record of the current generation in power is that there is no cost today that they will not dump on tomorrow.
Until such time as responsibility becomes a civic virtue again, usually because of necessity, we will almost certainly have to wait, while the public votes for "moderate" leadership, and searches for a Hoover and a Chamberlin to follow its 21st century Warren G. Harding and Lord Stanley Baldwin.
As Churchill noted, "The American people will do the right thing, after they have done all of the wrong things."