Where Is All This Leading To?

It was a relentless, obsessive pursuit of wealth, a mania that soon gave way to panic and crash, bringing huge devalua-tions of net worth all around in their wake. By all indications, the developed capitalist countries are in the midst of the worst financial and economic crisis since the 1930s and it has now become legitimate to pose the question as to where is all this leading to. Will the growing financial precariousness and the impending deep recession take the economy into the kind of debt deflation that overwhelmed capitalism in the early 1930s? Or, as the more optimistically inclined would like to believe, will the developed capitalist world’s central banks, as lenders of last resort, be able to stabilise the financial markets and prevent the financial crisis from getting out of hand, and will a step up in government deficit financing, by invigorating aggregate demand and shoring up corporate profits, prevent debt deflation? The latter is understood as a general decline in prices associated with a massive slump in aggregate demand leading to ever-increasing real values of debts.

Interestingly,The Great Contraction, 1929-1933, the classic by Milton Friedman and Anna Jacobson Schwartz has been reprint-ed recently (Princeton University Press) with a new preface by the latter, and an introduction by Peter L Bernstein which looks at the book from the perspective of the most recent financial de-velopments. As is well known, Friedman and Schwartz claimed that the cause of the Great Depression’s persistence and severity was due to the failure of the Federal Reserve Board to act as monetarists would have considered proper. But when the state of long-term expectations as regards the prospect for profitable investment opportunities, what Keynes called “the marginal efficiency of capital” is at its lowest ebb, and a sharp decline of the velocity of money is associated with the near extinction of the process of credit creation, how can one still have illusions about the omnipotence of monetary policy? (Incidentally, there is not a single reference to Keynes in Friedman and Schwartz’s A Monetary History of the United States, 1867-1960 of which The Great Contraction is its chapter 7.) Indeed, in the present, the very act of taking controlling share stakes in the major banks (as in the United Kingdom, the United States, and other countries) is in effect acknowledging that the problem is not one of liquidity but of solvency, and it cannot be dealt with by merely “dropping money from helicopters” into the financial markets and lowering interest rates (the banks are merely in-vesting the additional money in government securities, negating what the Fed is trying to achieve). The process of credit creation has stalled because there are widespread solvency problems (because of the declining value of banks’ financial assets) and there is recognition all around of an impending downward plunge of aggregate demand.