“… weapons producers want governments to underwrite the profitability of their investments. This is precisely the alliance between industry and the state that formed the basis of the military Keynesianism that Michal Kalecki criticized during the 1950s. He showed how, at the height of the Cold War, Western governments subsidized private capital with arms contracts paid for by taxpayers.”

photo flickr

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Jan Toporowski will be speaking on Russia’s war and its impacts at PEF’s Progressive Economics conference at the University of Greenwich on June 11. You can book your tickets here.

Russia’s catastrophic attempt to gain re-entry into the league of great powers, after its re-entry into capitalism reduced the country to a raw materials supplier to stronger economies, calls to mind Polish economist Michal Kalecki’s remark about the fascist promise to humiliated nations after the First World War, that ‘roads to glory lead to war.’ In the violence into which this latest ‘road to glory’ has descended, it is sometimes forgotten that Russia may possess the largest army in Europe (and possibly in the world, depending on how much weight is given to reserve soldiers). But economically it has not recovered from the loss of the peripheral republics of the old Soviet Union, and the ‘shock therapy’ of economic liberalization after the Russian government abandoned socialism. The World Bank estimates that Russia now is merely the 11^th largest economy in the world, not only after the United States, China, and Japan, the European behemoths of Italy, France, the United Kingdom, and Germany, but also the ‘emerging markets’ of India and South Korea.

Russia’s claim to great power status is therefore based on its stock of nuclear weapons, its economic function as a petrol pump for Europe, and an army that is far from sweeping all before it in Ukraine. It is to prevent the use of these weapons (and save on military casualties among their own citizens) that the powers in Europe and North America have preferred to use economic sanctions, in the hope that further impoverishment degrades the national dignity that is being restored with such violence and might evoke mutiny in the Russian elite.

The possibility of such a mutiny cannot be accurately assessed by anyone outside the Kremlin. And further impoverishment will be significant, but will affect largely the consumption of the wealthier middle classes, who have the most to lose from payment restrictions on imported goods and the joys of foreign travel. Although there are reports of Chinese banks refusing letters of credit to Russian customers out of fears that they may be declined facilities by US banks or face fines of their subsidiaries in the US, Russia retains access to the international payments system of China. And the Indian government is helping to set up a system for the exchange of rouble-rupee payments, although Indian banks will also be wary of possible retaliation by the US.

Russian foreign exchange controls require traders to surrender 80% of their foreign earnings for conversion into roubles, and the Russian government has demanded payment for Russian oil in roubles. This is helping to stabilize the rouble exchange rate, after it fell to nearly half of its pre-war value against the US dollar, while international prices of oil and natural gas are benefitting from additional supplies. However, much of these restrictions on foreign exchange transactions are journalistic hyperbole: The demand for payment in roubles is actually a requirement to deposit dollars in Sberbank or Gazprombank to buy the roubles required to pay for oil. And the obligation placed on traders to surrender dollars means that the Russian foreign exchange market has in effect been brought onto the balance sheet of the Russian central bank, where the central bank decides the rate at which it buys those compulsorily exchanged dollars.

The talk in the commodity markets is of the emergence of a two-tier system in which a fairly high official price is paid for energy and raw materials, but half the price is charged for such products from Russian sources. Similarly, Russian consumers may expect to pay well above the market price outside Russia for their imported goods. In the food-deficient Middle East, food prices are already rising and will rise further, as war affects Ukrainian agriculture. This coincides is the breakdown of cheap off-shore manufacturing, as global supply chains are disrupted: At the beginning of March, Volkswagen temporarily stopped production of electric cars in its factory in Zwickau due to the failure of supplies from Ukraine.

Wisdom and foresight

These unprecedented shifts in international markets have moved our business and financial leaders, on whose wisdom and foresight our prosperity is supposed to depend, to declare a new (inflationary) era in world economic affairs. Towards the end of March, as the war entered its fifth week, Larry Fink the Chief Executive of BlackRock, the world’s largest asset manager, wrote to his shareholders at the end of March that ‘The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades… A large-scale reorientation of supply chains will inherently be inflationary.’ (Financial Times 26 March 2022). Fink had in mind the disruption to cross-border supplies due to the war and revulsion against doing business with Russia.

But globalization is more than this, and less. It is more than just ‘global supply chains’ assuring cheap raw materials and components to assembly plants on the fringes of industrial centers. Behind this is a system of worldwide payments, necessary for settling trade and debt obligations in different countries. The Society for Worldwide Interbank Financial Telecommunications, or SWIFT, is a network of 11,000 banks around the world through which most cross-border payments are routed. Although ostensibly a co-operative of member banks, it has agreed to remove select Russian banks from its messaging system, through which cross-border payments are made. However, Sberbank and Gazprombank have so far been spared expulsion from the payments system because German oil and natural gas importers pay for their imports through those banks. Pressure is now building up in Germany and Austria to eliminate such imports. But as long as imports continue, the banks through which they are paid have to be allowed to transfer such payments.

The US Federal Reserve also offers currency swap facilities to selected other central banks, in Europe, but also in Japan, Mexico, Brazil, and South Korea, allowing those central banks to draw dollars that are necessary as backing for many international transactions. The central banks outside the US, benefitting from these facilities, will of course be careful not to jeopardize their access to currency swap facilities by allowing commercial banks to make payments that bypass US sanctions. This is in addition to the freezing, shortly after the invasion of Ukraine, of up to 40% of Russian reserves held in markets outside Russia.

It is possible to argue that this international payments system is really at the heart of what is called globalization because it is the system that allows money and capital to flow between countries. In the heady years following the dissolution of the Soviet Union, when Francis Fukuyama celebrated the end of history, this international integration of finance underpinned the globalization announced by Anthony Giddens and Zygmunt Bauman.

Lived experience

But the lived experience of globalization was always less than this. Russia and China did eventually join the World Trade Organisation and the International Monetary Fund. But the development of free trade and international payments systems was largely regional, most notably in Europe with the establishment of the European Union and its Single European Market, and in North America with its North Atlantic Free Trade Agreement (superseded in 2020 by the US Mexico Canada Agreement), with other regional agreements in the cone of South America, in West Africa, Southern Africa, and South-East Asia. Most of the world’s population, in India, China, and the poorer countries of the world, make no use of international payments and live in countries where cross-border trade and its associated payments are strictly controlled. In those countries, only a wealthy minority with financial assets in off-shore territories, such as Mauritius and tax havens in the Caribbean, can move their deposits freely around the world. And even in countries where such payments are unrestricted, that freedom is only within the territories of associated countries. ‘Globalization’ always promised more than it delivered.

This system of regional trade and payments areas was already fragmenting before the War in Ukraine. The most spectacular case has been the departure of Great Britain from the European Union, ‘going global’ to set up barriers to international trade and payments. But perhaps the biggest push towards that fragmentation has been the use of economic sanctions by the United States as an alternative to military persuasion, which is perhaps Donald Trump’s most significant innovation in statecraft. Sanctions require only an Executive Order signed by the President of the United States. But US banks also have a central position in the international financial system. US commercial banks provide dollar-based foreign exchange swaps (between commercial banks, backed also by central banks’ currency swaps with the Federal Reserve) as security for credit transactions in other currencies. This means that banks in other countries cannot bypass US sanctions without losing the foreign exchange swap facilities with US banks that foreign banks need to conduct their business. This banking and financial power will now ensure that most banks around the world fall into line with US sanctions.

Over time, the economic sanctions imposed in support of Ukraine will have important economic consequences. The cost of living in virtually all countries of the world will rise, on top of the price inflation that was already taking off even before the war started. This will be blamed on the war, and declared by all right-thinking people to be part of the sacrifice that is necessary to defend democracy and peace against autocracy and war. But, short of rationing, natural catastrophe (such as Covid), and war, there is very little that makes people change their patterns of day-to-day expenditure, even if they may now season their expenditure with complaints about the prices now being paid for their customary shopping. This will allow the government of Russia and its friends to declare that the economic impact of sanctions has been contained and they are not really working.

Profiteering

However, there is something else that is happening that is no less real than inflation, even if it is less obvious than the rise in inflation. When international markets and payments systems fragment, it is the arbitrageur who makes money, at the cost of producers and consumers. Consider the market for luxury imported goods in Russia, such as German cars or French wines. These will not cease to be available in Russia. But they are already becoming much more expensive, both because of the depreciation of the Russian rouble against the Euro, and because of the more roundabout methods now necessary to secure shipments of these goods and pay German and French exporters for them. In the oil market, traders will seek out Russian oil that they can buy at a much lower price, in devalued roubles perhaps because of sanctions, but refined products like petrol will be supplied at a price above the much higher price for non-Russian oil.

In short, economic sanctions against Russia are adding to a major redistribution of income from workers and middle-class consumers to profits in international trade. It reinforces the boost to profits in the armaments industries as governments around the world expand their military capabilities and supplies to the combatants in Ukraine. This shift in distribution comes at a time when, in the recovery from Covid, business corporations are raising their prices to recover revenue lost due to measures taken by governments to suppress Covid, and to repay the debts run up by those corporations during the pandemic.

Profiteering from military and economic warfare needs to be exposed and challenged. Given the existing institutions of international capitalism, it is difficult to suppress such profiteering. But it can be taxed, as such profits were in Britain and the United States during the Second World War, to pay the costs of aid to Ukraine, refugee relief and the reconstruction of health services, and to protect the living standards of the less well off. Our captains of business and generals of finance should welcome the opportunity to contribute to the defence of liberal values. The Ukrainians are paying for their democracy with their blood and their lives; working people and their families around the world should not also have to pay for the profits that are made out of that struggle.

Republished from INET. The author is grateful to Noemi Levy-Orlik, Riccardo Bellofiore, Thomas Ferguson and Joseph Halevi for comments on an earlier draft.

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Jan Toporowski

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Robert Skidelsky

Will Hutton

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The usual (Keynesian) answer is that government debt doesn’t matter, since a government deficit activates a fiscal multiplier to allow debt to be repaid out of the resulting economic growth. However, recent evidence has cast doubt on the idea that the fiscal multiplier will be sufficiently high to generate sufficient economic growth. It turns out that the fiscal multiplier (the ratio of the fiscal deficit to the resulting economic expansion) itself may be ‘endogenous’, in the sense of being too low in recessions, or periods of low growth (secular stagnation).

The first step towards understanding government debt is the realisation that government debt is not like the mortgage that takes a large chunk of working life to pay off. Looking at how debt structures affect the circulation of money shows up the differences. To start with a distinction emerges between borrowing abroad, ‘outside’ debt, and domestic borrowing, or ‘inside’ debt. ‘Outside’ debt is indeed pernicious, because it commits to the future transfer of resources to persons or institutions outside the economy. Such was the problem of British governments in the two World Wars of the last century, when Britain had to borrow abroad to secure supplies for the war effort and to feed, clothe and fuel the population at home. A similar problem is faced by governments of developing countries today which are encouraged to borrow abroad, when international money markets are liquid. The repayment effort then requires either refinancing (‘kicking the can down the road’ as it is called in banking circles), or a drain on foreign currency reserves, augmented by a deflationary squeeze on imports.

Domestic borrowing, or ‘inside’ debt is, however, different. It commits to the future transfer of resources to persons or institutions within the economy. So, unlike ‘outside’ debt, it keeps resources within the economy, merely redistributing them. Whereas ‘outside’ debt is a burden on our children and grandchildren, ‘inside’ debt is merely a commitment to make our children pay taxes to defray the interest and repayments to our children who hold government debt. In other words, domestic borrowing commits future generations to pay money to future generations. This is a promise to transfer money within the same generation, rather than, as fiscal conservatives argue, between generations. External debt indebts our children to outsiders. Internal debt indebts our children to our children.

This leads to a first principle of government debt management, namely that government borrowing should be domestic, rather than external, in order to keep financial resources within the economy.

It is at this point that debt management and the incidence of taxation come into play. If we assume, for the sake of simplicity, that government borrowing is done through the sale of bonds, then those bonds will end up in the financial portfolios of those persons who are wealthy enough, or have sufficiently high incomes, to have savings backed by those bonds. However, payment of taxes is much more widely distributed. Government borrowing in domestic markets commits tax-payers in general to provide interest income to bondholders who are usually in rather more favourable financial circumstances than tax-payers. The outcome of this redistribution is therefore regressive, although the degree of regression depends on the structure of the tax system. Supposing that the costs of servicing government debt are paid for by an increase in Value Added Tax. Since this is a tax that is paid mostly by people on average or below average incomes, the result will be to transfer income from persons of modest incomes to those on higher incomes. The freezing of public service salaries announced in the Autumn Statement, represents a similar kind of regressive transfer.

This therefore leads to a second principle of government debt management, namely that in societies characterised by inequality of incomes and wealth, government debt requires tax rates to be made more progressive as the debt rises, in order to avoid increasing that inequality. This is where the propaganda about government debt as a burden on our children is used for regressive purposes in persuading people of modest means that it is either them or their children who should pay off the debt. There is an alternative: people with higher incomes and owners of wealth should pay.

There is a very sound economic reason for making wealthy people with high incomes pay the costs of government debt. These are people with savings. When their taxes are increased, this may affect their savings. But it usually has no effect on their expenditure. People with savings are also the principal holders (directly or indirectly) of government bonds. Higher taxes to pay for those bonds therefore take money away from the wealthy classes, and returns it to them in the form of payments of interest and principal on the bonds. The overall cash position of the wealthy classes remains unaffected by the higher taxes.

By contrast, if taxes to service the government debt are raised on households and small businesses whose incomes are too low for them to be able to save, then their expenditures are in effect squeezed. What amounts to the same thing occurs if government employees find their salaries frozen in order to service the debt. The squeeze on household expenditure then tends to reinforce deflationary pressures in the economy, not so much because consumption is reduced, but because people who might not otherwise do so enter the labour market to earn additional income, and the added competition drives down wages.

The third principle of debt management is therefore that, to avoid detrimental effects on economic activity, higher taxes to service government debt are best levied on higher incomes and wealth. This assures financial stability by maintaining a stable cash position among the wealthy, and has minimal effect on aggregate demand and economic growth.

This should reassure prudential parents about the security of their childrens’ futures. However, the anxious parent will also wish to know whether there is any upper limit on this kind of ‘internal’ borrowing. This was suggested by Carmen Reinhart and Raghuram Rajan a few years ago, in a study that claimed to show that government borrowing in excess of 90% of GDP was usually followed by financial crisis. It turned out that the Reinhart and Rajan study was marred by some methodological flaws. But the principal reason why it should be dismissed by prudential parents today is because it muddled up ‘inside’ and ‘outside’ borrowing: The ruin of Florentine bankers by the default on King Richard the Lionheart’s borrowing to finance his crusades, like the Third World debt crisis of the 1980s, was clearly a case of ‘outside’ borrowing, whose dangers are not diminished here. A more relevant historical example is the British government debt after the Second World War, which reached 250% of Gross Domestic Product: far larger than any possible British government debt today. It was eventually brought down not by draining the resources of taxpayers with fiscal surpluses and public servants with penury, but by inflation and economic growth.

The provident parent should therefore put away the piggy bank, reject Conservative alarums about public debt, and assist their children into a profession whose pension will be soundly backed by government bonds serviced by taxes on the rich.

Jan Toporowski is Professor of Economics and Finance at SOAS University of London and a member of the Council of the Progressive Economy Forum. He has worked in international banking, finance and central banking, and has published ‘Why the World Economy Needs a Financial Crash’ and other Critical Essays on Finance and Financial Economics (London: Anthem Press, 2010).

Picture credit flickr  www.epictop.com

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Even a few years ago such views would have been seen as heretical: it was assumed that a return to the system of macroeconomic management that prevailed before the financial crisis was just around the corner. Instead, discussion is now dominated by the tools that central banks should turn to next: helicopter money, deficit monetisation or negative interest rates? Demands are also growing for central banks to join the fight against climate change.

The disintegrating conventional view, that a return to pre-crisis orthodoxy is both possible and desirable, mirrors what Henderson and Keynes called “the fashionable view” of the 1920s: the view that all that was necessary to recover the sunny, predictable comforts of Edwardian empires was a return to the monetary arrangements that obtained before the war.

On the 90th Anniversary of Henderson and Keynes’s “Can Lloyd George Do It?“, which argued against this view, and in favour of Lloyd George’s programme of public spending, we have written a report for the Progressive Economy Forum on the effectiveness of the Bank of England’s monetary policy.

The report argues that a reversion to pre-crisis central banking is neither possible nor desirable. Just as the Bank did not have the capacity to stabilise the pre-crisis economic system — stable inflation during this period was, instead, due to factors outside the Bank’s control — it does not have the capacity now to achieve stabilisation using a broader array of tools. Nor does it have the power, acting alone, to achieve productivity targets or a carbon-neutral transition.

The principal reason why pre-crisis central banking is not possible is that the Bank of England now has a substantial balance sheet which cannot be reduced without adverse consequences for capital markets in Britain. The principal reason why pre-crisis central banking is not desirable is that it was precisely that model of central banking, restricting monetary policy to the management of short-term interest rates, that contributed to the crisis that broke out in 2007 and caught the Bank of England by surprise. The Labour Party’s review of policy offers an opportunity to re-examine how central banks can contribute to stabilising economic activity at high rates of employment.

The report reviews various proposals that have been put forward for enhancing the responsibilities of the Bank of England. Targets for productivity would work in a perverse way and may create unemployment, while credit support for greening the economy requires a much greater investment irrespective of Bank support. The report concludes that the Bank has limited instruments for influencing economic activity, and those instruments should be concentrated on what the Bank can do effectively, which is to contribute to economic growth and prosperity by maintaining financial stability. We therefore argue that the Bank should be given an enhanced financial stability mandate in the form of a target to conduct open market operations to keep the yield curve stable. This should be implemented through a policy of open market operations aimed at keeping rates of interest at different maturities stable at levels that support the solvency of financial institutions, and the availability of finance for investment. This is what the Bank of England can do. Stabilisation of the economic system and regulation of employment and investment is a matter of policy for Government, not the central bank.

The full report can be read here. Photo credit: Flickr/Dun.can.

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