If asked to choose between full employment and constant purchasing power of existing money, most ordinary people would lean towards job creation. That’s because almost all of us are dependent on employment for our income. Not so for people with lots of money. For them maintaining the “value” of what they’ve got is paramount. That’s because capital (piles of cash) is the source of their income. It’s no surprise then, in this era when the self-interest of the rich and powerful trump all else, that central banks opt to limit inflation at the expense of job creation.
What is surprising, however, is how little the left has paid attention to this key plank of neoliberalism. As opponents of neoliberal ideology we denounce “free” trade (investment) agreements, cuts to social programs, corporate deregulation, privatization of public institutions/space and the liberalization of labour markets. Less often, however, do we challenge the no inflation at all costs monetary policy. In fact, the right has almost total control over monetary policy on both an ideological plane and, in most countries, tangibly through central bank independence from political control.
It is time we fight back against neoliberal monetary policy’s domination within both economic departments and the popular debate. To do so we need to critically analyze interest rates and inflation through both a class perspective and a center/periphery model.
Interest rates and inflation
Interest is ostensibly the payment for money borrowed. Yet today interest rates are, in large part, set by central banks that buy and sell government securities. Depending on the country, interest rates are set based upon numerous economic factors (inflation, employment, growth). Usually central banks increase interest rates to reduce inflationary pressure or reduce interest rates to stimulate the economy. This means that money is made either more or less expensive to borrow. When money is less expensive prices are more apt to rise (inflation) since money is easier to acquire. When money is more expensive inflation is more likely to subside and the economy tends to move more slowly.
Inflation is the scourge of neoliberal (monetarist) economists. According to Milton Friedman and Frederick Hayek, the early ideologues of neoliberalism, inflation disrupts communication in the marketplace. And since neoliberals have the utmost faith in “free” markets, inflationary “noise” is a serious concern. To combat disruptive noise neoliberals usually demand curbs on government spending and a tight money policy, no matter their effect on employment or even the economy in general. Hayek states “it must remain one of the chief tasks of monetary policy to prevent wide fluctuations in the quantity of money or the volume of the income stream, the effect on employment must not be a dominating consideration guiding it. The primary aim must again become the stability of the value of money.”
While Hayek and Friedman’s views on monetary policy have more or less won the day that has not always been the case. Keynesian welfare state economics dominated at the time of their writing. Keynesianism usually supports low interest rates to allow for aggregate demand creation and even some emphasis on full employment.
Part of neoliberal opposition to inflation is intertwined with an attack against unions and working people’s wages. Hayek claims, “what has led governments to such [expansionist monetary] policy was chiefly the activity of trade unions and similar activities by other monopolistic bodies (such as the oil cartel).” On one count he’s right. Some unions have, rightfully, pressured governments to adopt expansionist monetary policies that are beneficial to their members’ interests no matter their effect on the wealth owning class.
As defenders of wealth, neoliberals also fear inflation because it can have redistributive effects. Edward Foster writes, “an increase in the rate of inflation would redistribute wealth in a modest way from the upper 20% to the lower 80% of the population ranked by wealth.” The majority of us do not have large savings so when inflation rises, comparatively, we don’t have much money devalued. Likewise inflation redistributes wealth from creditors to debtors, when debts are stated in fixed dollar terms. Not surprisingly, banks and those who own wealth are more apt to dislike inflation. In fact, part of the neoliberal backlash, in Canada at least, was pre-empted by a couple of years of negative real interest rate returns, which freaked out creditors (The real interest rate is the difference between the nominal interest rate and inflation i.e. 6% inflation and 8% interest rate = 2% real interest rate.).
Of course, inflation is not simply good for workers and the less wealthy, while bad for wealth holders. Extreme inflation can have catastrophic effects on the working class. Even medium levels of inflation can be problematic to those on fixed incomes without proper bargaining procedures.
Inflation, however, should be secondary to policies of full employment and wage increases. The point of an economy should be the greatest good for the greatest number. Yet for the neoliberals inflation always takes precedence over other economic indicators, as was the case four years ago when Alan Greenspan, with the backing of the other monetarists who dominate today’s economic discourse, increased interest rates to curb possible U.S. inflation. The unemployment rate had dropped below four percent and the business community was becoming fearful that lower unemployment would increase labor’s bargaining position, thus driving up wages and cutting into profits.
Interest Rates and neoliberal globalization Since the dismantling of the Bretton Woods institutions (exchange rate agreements made after the Second World War) during the early 1970s and the controls on capital they provided, national interest rate policies have become more constrained to worldwide trends. It is estimated that worldwide currency speculation is upwards of $1.2 trillion daily. Currency speculators are profit maximizers so they move their money to whichever country will provide them with the largest profits (not to whichever economy is most productive). Though the real interest rate is not the sole reason for investment in a country’s currency, it is a considerable one. Block writes, “governments that planned to lower domestic interest rates to stimulate employment are likely to experience crippling outflows of capital in pursuit of higher interest rates elsewhere.” The reduction on capital controls brought about by the dismantling of the Bretton Woods institutions makes this easier. Block emphasizes this point by comparing interest rates in France and the United States during the Bretton Woods period. “Between 1961 and 1972 France’s system of capital controls produced interest rates that were one-hundred and five basis points below those of the United States.”
This made it easier for France to pursue expansionary economic policies without succumbing to the power of international investors, who certainly would have moved large amounts of their wealth to the U.S.
A more open international investment market pushes countries to match each other’s interest rates. It also provides the framework that allows countries to better their competitors’ interest rates. To some degree, it initiates a race to the top, whereby countries raise their real interest rates to attract investment. This is similar to the race to the bottom that trade and investment agreements propel with wages and environmental policies. A country that increases its real interest rates – no matter the unemployment situation – will often garner a larger chunk of international investment.
At the start of February the Wall Street Journal reported that ” last yearâ€¦.
[Brazil] launched a policy of tight money and austere spending to counter attacks on Brazil’s currency and an inflationary surge. While the economy stagnated [unemployment rose and real wages declined], Brazilian bond and currency markets rallied strongly.” (Feb 6) It’s not surprising that bond and currency markets did well even as the economy declined since “Brazil still has the highest real interest rates in the world.” President Lula’s administration went out of its way to reassure international investors that Brazil wasn’t going to stray from the neoliberal program, even if it meant turning its back on the union constituency that brought them to power. (To be fair to Lula it’s a little more complicated since a large amount of Brazil’s debt is in U.S. dollars or fixed to the U.S. dollar and any drop in the value of the Brazilian currency, the Real, increases the country’s debt service charges and likelihood of default.) Minqi Li writing in Monthly Review explains: “As a result of financial liberalization, cross-border speculative capital flows have greatly increased, raising the danger of capital flight and financial crisis.
Against such dangers, some central banks are forced to maintain high interest rates, in effect paying a risk premium to global finance capital. The average ratio of real interest rate to GDP growth rate in the seven leading capitalist economies was 0.97 between 1881 and 1913, 2.40 between 1919 and 1939, 0.36 between 1946 and 1958, 0.55 between 1959 and 1971, 0.47 between 1972 and 1984, and 2.34 between 1985 and 1997. It is worth noting that the real interest rate has been higher than the economic growth rate only in two periods, the interwar depression years and the neoliberal era. A ratio greater than one implies an inversion of the roles of productive and speculative investment, and is a signal of systemic crisis.” (Jan 2004) Higher real interest rates worldwide lead to larger sums of currency speculation. This happens for two main reasons. In a capitalist economy the market is not simply a tool to allocate goods but rather first and foremost a mechanism to create profit so those who have their money in other less profitable (productive) investments will move their money to currency speculation when there are higher returns available there. Also currency speculators who receive a larger profit over time will have more money with which to speculate and will push for political changes to facilitate more speculation.
And while money invested in non-productive (speculative) ventures may produce profits for a few already wealthy people, it has little to no benefit for the majority of people. This is unlike investment in productive enterprises such as factory expansion, which can increase workers bargaining power, because large capital investment is relatively immobile. In addition, ordinary people can benefit directly from productive infrastructural investment, particularly publicly funded low-cost housing or public transit or expansion of schools. However, higher interest charges increase governments’ debt charges and so reduce the amount of money governments have to spend on infrastructure or social programs.
Jim Stanford, an economist with the Canadian Auto Workers and author of Paper Boom, argues that the most prosperous time for Canadian workers coincided with a period of relatively low real interest rates. He also found that between 1981 and 1998, the real interest rate increased in Canada, which coincides with a decrease in the real wages of Canadian workers. He concludes that low interest rates are almost always a good thing. Low interest rates propel growth, which tends to benefit the working class.
It’s not surprising then that the annual growth rate was higher during the Keynesian period then it is now. “The average annual growth rate of world GDP declined from 4.9 percent between 1950 and 1973, to 3.0 percent between 1973 and 1992, and to 2.7 percent between 1990 and 2001. Between 1980 and 1998, half of all the “developing countries” (including the so-called “transition economies”) suffered from falling real per capita GDP.” (Monthly Review Jan 2004) Increased interest rates are also a significant reason for the majority world’s debt crisis, which started in the early 1980s and continues today.
Fidel Castro explains: “it was actually the swift and arbitrary increase of interest rates on the U.S. dollar â€¦that created the debt crisis in the first place.” Overnight, governments that borrowed in U.S. dollars were required to repay more money. This meant more borrowing more from the IMF in a spiral of increased debt that results in “structural adjustment programs” that forces ever harsher neoliberal terms on countries where real investment in productive enterprises is desperately needed.
One staple of “structural adjustment” agenda imposed on poorer countries is the total liberalization of finance, which has resulted in an increase of short-term speculative capital, ‘hot money’. Joseph Stiglitz, in Globalization and its Discontents, writes ” to manage the risks associated with these volatile capital flows, countries are routinely advised to set aside in their reserves an amount equal to their short-term foreign denominated loans. To see what this implies, assume that a firm in a small developing country accepts a short-term $100 million loan from an American bank, paying 18% interest. Prudential policy on the part of the country would require that it would add $100 million to its reserves. Typically reserves are held in U.S. Treasury bills, which recently paid round 4%. In effect, the country is simultaneously borrowing from the United States at 18% and lending to the United States at 2%. The country as a whole has no more resources available for investing. American banks may make a tidy profit and the United States as a whole gains 16 million a year in interest.” Interest rates or specifically the higher rates poorer countries have to pay are a tool of control in the hands of the wealthier nations.
Of course, interest rates aren’t the only reason for investment in a country. Nor do countries have to constantly increase their real interest rates in a post Bretton Woods world. Some countries have the ability to reduce their real interest rate without causing drastic outflows of capital, as the U.S. is currently demonstrating. However pressure on real interest rates is usually upwards in the post Bretton Woods world. High real interest rates increase the sum of international currency speculation at the expense of productive enterprise. Higher real interest rates have a similar effect around the world. Ultimately there is a distribution shift from poorer countries to richer nations and between the working class and wealth holders. In plain language, neoliberal monetary policy is all about the rich getting richer and damn the consequences on most of the world’s population.
Yves engler can be reached at [email protected]