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Global Financial Crisis

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Keynes, Inflation and the Green New Deal
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Keynes’ monetary policies provides the best guidance on how to get the financial system under control so that society can embark on the economic transformation needed to get us from a fossil-fuel based society, to one based on sustainable renewable fuels, argues Ann Pettifor.


2nd September 08 - Ann Pettifor, Debtonation.org

I am getting feedback from those who have read the Green New Deal (GND) (which I co-authored) complaining that the Keynesian policies espoused therein will simply drive us back to the 1970s, to militant trades unionism and ’stagflation’. Their concerns need a response.

Attacks on Keynes are not new. The policies and ideas attributed to Keynes are often very different to what he wrote, and what he stood for. His name is a dirty word in many academic and financial circles, and his detractors have ensured that their version of history prevails in the stories the labour movement, the finance sector, governments and academia tell about the 1970s. As I lived through and was politically active in the labour movement during that period, and as a defender of Keynes, this is a brief attempt to put the record straight.

From the 1960s onwards, the post-war monetary environment that Keynes had set up (capital controls as well as control over credit-creation or domestic money creation) was being dismantled. The most direct reversal was the Conservative Government’s 1971 Bank of England Competition and Credit Control Act (characterised as ‘all competition and no control’) on the one hand, and on the other, the collapse of the Bretton Woods system.

The 1971 Act and other measures facilitated the ‘Barber boom’, named after the Conservative Chancellor of the time, and ensured that constraints on government spending and personal consumption were lifted. This of course triggered an inflationary spiral. Trades unionists naturally responded to this rise in prices, and defended the living standards of their members. To blame the by now long-dead Keynes or the unions for the inflation of the 1970s is outrageous. The blame rests fairly and squarely with so-called ‘monetarists’, the ideologues of the Chicago school, Conservative and subsequent Labour governments that swallowed the financial de-regulation ideology whole.

‘Keynesian inflation’ and Keynes as an ‘inflationist’ is the dominant interpretation of events in the 1970s, and is not contested - least of all by economists in academia, or by the trade union movement itself. Indeed the Labour movement, and certainly all Labour governments, love to engage in self-flagellation over the 1970s, and accept all blame……a sure sign of weakness.

The US withdrawal from the Bretton Woods system was another contributor to the stagflation of the 1970s and, we contend, to the oil crisis of that period. It was precipitated by President Nixon in 1971 when he unilaterally defaulted on the post-war Bretton Woods agreement that the US would link the dollar to gold, and in time would default on the agreement to maintain balance in her external accounts, i.e. keep imports in line with exports.

In 1971, out of the blue, Nixon announced that the US would not repay debts in gold - instead offering paper (the ‘greenback’) to all of the its creditors. (This issue is dealt with in more detail in chapters of my book explaining the historic backdrop to The Coming First World Debt Crisis. ) This was and still is, the biggest sovereign default on foreign obligations in history. It makes Argentina’s partial default in 2001 look like a walk in the park.

The decision not to repay in gold came about because the US had spent too much on the war in Vietnam and on rebuilding The Great Society, and had literally run out of gold in the vaults of Fort Knox. President De Gaulle of France insisted that exports be paid for in gold as he did not trust the dollar. It was this French intransigence that precipitated Nixon’s arbitrary and unilateral decision.

After the collapse of the Bretton Woods system, the IMF was later charged with re-building the international financial architecture, but failed to come up with a scheme. Thereafter loans to the US - Treasury Bills - became the basis of all international exchange and government reserves and the dollar took on its role as the world’s reserve currency.

Because gold was no longer the anchor for the world’s currencies, the US was able, simply by virtue of acting as the world’s banker, to oblige the rest of the world to to convert surpluses into Treasury bills, and thereby provide the US with loans, at very low rates of interest. As a result the US quickly moved from being the world’s biggest creditor and became the world’s biggest debtor. This has led to the extraordinary global injustice whereby countries with large numbers of poor, like China, lend their surpluses to the US government and its citizens. It is this generous, if obligatory funding which has effectively financed the US (and also UK) consumption boom of the last decade. In other words, both the US and the UK have been able to live well beyond their means, thanks to the structure of the international financial system and the generosity of very large numbers of poor people.

At the same time, the decision by Nixon to default on US obligations undermined confidence in the dollar, and caused it to fall dramatically (there’s more in the chapter on third world debt in my book). As the dollar fell (remember oil sales are denominated in dollars) oil producers were obliged - if they were to maintain revenues in dollar sales - to raise the price of their product. The story of the 1970s oil crisis is often told as if oil producers spontaneously raised prices for no other reason except to harm the west. Not so.

The rise in the oil price generated billions of dollars for oil producing countries, money which was banked in western banks. This inflow of money threatened to worsen the inflation of the 1970s - so the money was re-cycled - to poor ‘third world’ countries as new loans. Therein lay the seeds of the Third World Debt Crisis.

Precisely the same oil price dynamic is in play today. If you have watched the movement in the oil price you will notice that it precisely correlates with the dollar’s movements. As the dollar falls, the price of oil rises, as the dollar rises, oil prices fall. Of course this is not the only determinant of the oil price, and peak oil is a big part of the problem….but it is striking how closely they correlate.

The second general attack on the Green New Deal’s espousal of Keynes’s policies is the charge that he is a ‘consumptionist’.  His primary concern in the 1930s was to get the economy working. Remember that when he was writing there were 10 million people unemployed in Germany, the UK and the US.  So promoting spending and economic activity was merely a way of trying to revive the comatose body that was the economy.

It is true that he celebrated consumption, but he was doing this to counter the austerity of the neo-liberals, whose philosophy was based on the ‘crowding out’ notion still fashionable today: i.e. that if consumers didn’t spend, then money could be freed up to be spent by big business, which could be better trusted with the money. Similarly, argued the neo-liberals, government spending curtailed free market capitalist spending which was always perceived to be more efficient than (in their terms) ‘the rent-seeking’ policies of governments. So neo-liberals almost celebrated the suffering and unemployment of that period, and had no policies to alleviate the suffering.  Keynes provided the policy framework that helped end the crisis, and for several decades promoted prosperity.

But - and this is the most important point to note - Keynes’ main mechanism for reviving the comatose body of the economy in the 1930s was not spending - government or personal expenditure.

It was reform of the monetary system, for which he is seldom given full credit. The neo-liberals have always defined him as ‘fiscal Keynes’ - an ‘inflationist’ reckless about government spending. In fact, he promoted government spending as a reaction to the debt-deflationary crisis brought about in the 1930s by the excess availability of credit, the massive expansion of asset bubbles (in particular the stock market bubble) - all a result of the de-regulation of the finance sector. Keynes was about controlling the finance sector through control over the domestic financial environment, through capital controls. He did not primarily promote  government spending to revive the economy.

Domestically Keynes was for a regulated, domestic financial environment with very low interest rates. Remember that the revival of activity under a regime of low interest rates, stimulated the private sector, not just the public sector. In the 1940s, 50s and 60s his policies worked very well….the era is known as ‘the golden age’ and we should not let the false memories of ‘monetarist’ finance-driven policies of the 1970s and inflation - detract from that.

Internationally he was about stabilising government external balances (including imports/exports) and tried to achieve this through the Bretton Woods agreement. The abandonment of the Bretton Woods framework has led, since the 1970s to the massive build-up of imbalances in the global economy - massive deficits (e.g. the US and the UK) on the one hand, and surpluses (e.g. China) on the other.

If he was alive now, and was aware of climate change, he would no doubt have responded accordingly. With the financial system under control, governments are in a position to make the economy do as they want. So during the war Keynes ensured that resources were allocated to government, and taken from consumers to address the threat posed by Hitler, and  limit the threat posed by inflation .e.g. through his ‘deferred pay scheme’. These were mechanisms that could be put to use by society for adapting to major threats - like Nazi Germany or Climate change.

The GND is about getting the financial system under control so that society can now embark on the economic transformation needed to get us from a fossil-fuel based society, to one based on sustainable renewable fuels. Keynes’s monetary policies provides the best guidance on how to get there.

In ‘Economic possibilities for our grandchildren’ (1928) Keynes wrote “I see us free therefore, to return to some of the most sure and certain principles of religion and traditional virtue…that avarice is a vice, that extraction of usury is a misdemeanour, that the love of money is detestable, that those walk most truly in the paths of virtue and sane wisdom, who takes least thought for the morrow…We shall once more value ends above means, and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day, virtuously and well, the delightful people who are capable of taking direct enjoyment in things…the lilies in the field who toil not, neither do they spin."

Finally, on growth. There is no question that Herman Daly, the visionary ecological economist is right on the physics and economics of limits to growth. What we propose in the GND is not more economic growth, but economic activity, which does not have to imply growth. If economic activity is productive, if it takes place within the physical limits of the ecosystem, and if it is largely localised, it can be sustainable.

Central to the GND is our response to the threat posed by the coming Great Depression - which even Alastair Darling now concedes may be on the scale of the 1930s. There will be very high levels of unemployment, an enormous amount of social and political dislocation, and immeasurable personal pain - divorces, family break ups, suicides etc. . The GND calls for a ‘carbon army of green-collar jobs’ that will keep people economically active in support of vital productive activity - urgently needed to deal with the threat of climate change, and return the planet to sustainability.

It is so far, the only alternative policy framework on offer.

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