Repairing our democracy and rebuilding the economy go hand in hand. Democracy is not just about bowing to legitimate electoral outcomes, or civility in public life — it is also about the exercise of power in the economy. Unfortunately, the link between capitalism and democracy has been broken for more than four decades. At the root of this problem is the U.S. Federal Reserve, a government agency that stands outside of democratic politics. Forty years ago, the Fed became the most powerful institution in American economic life. Its history reveals just how much work there is to do for the new administration.
In 1981, Ronald Reagan was inaugurated president. In hindsight, Reagan’s victory seemed to usher in many economic trends that still shape American life, from the rise of Wall Street and Silicon Valley to increasing economic inequality.
But what first initiated these developments actually began months before Reagan’s inauguration: subsequent tax cuts and market deregulations. In 1979, President Jimmy Carter appointed Paul Volcker as chair of the Federal Reserve, America’s central bank.
At the time, Americans were suffering from double-digit inflation, which government had failed to tackle. Soaring inflation ate into the value of savings and wages. Many commentators, left to right, blamed the popular pressures of “democracy” — people expected too much from the economy and economic policymaking — for the crisis.
With Volcker in charge, the Fed raised interest rates to the stratosphere to stop prices from skyrocketing. But the high interest rates of the “Volcker shock” also choked off credit and enterprise, leading to a sharp recession that helped bring Reagan to office. Once there, Reagan left the Fed alone. When Volcker reduced rates in 1982, inflation had been quelled and a new economic era began.
The Volcker shock transformed patterns of capital investment. First, high interest rates compelled businesses to prioritize short-term profits over long-term investments, such as by parking cash in banks to earn profits on Volcker’s high interest rates, rather than investing in their businesses and hiring workers. This crushed manufacturing communities in the Northeast and Midwest.
The shift in priorities drove the rise of an economy more reliant on consumption and services. That boosted Sun Belt economies in the South and West, more dedicated to services and real estate.
These changes also contributed to the rise of speculative finance. In the 1980s, Wall Street began to move money rapidly, short term, across financial assets, like stocks and bonds. The Reagan-era boom was sustained by a rise in asset prices, especially in corporate stocks — Apple went public, for instance, in 1980, and its stock price immediately soared — and commercial real estate, where a young Donald Trump made his name. This new economic game rewarded wealth and those regions, including large coastal cities where wealthy educated Americans lived. As inequality increased, many other regions were left behind.
The U.S. economy has largely maintained this character ever since, and the Fed has backstopped its stability. The great risk in this economy comes when traders abruptly abandon one corner of the financial system, leading to a crash in the asset values that sustain economic growth. Enter the Fed, which can prop up values in the name of safeguarding the economy.
In 1982, for example, Volcker’s Fed handed a lifeline to banks hard hit by a Mexican sovereign debt crisis. In 1984, a Fed bank bailout gave rise to the phrase “Too big to fail.” After the 1987 stock market crash, a new Fed chair, Alan Greenspan, announced the Fed’s readiness to serve as a “source of liquidity” for financial markets. By the end of the 1980s, it was clear the Fed would backstop asset prices for the owners of wealth, who could trade with abandon, knowing this safety net existed.
But everyone else, the majority of Americans, could only hope for, at most, indirect benefits.
In 2004, future Fed chair Ben Bernanke dubbed this economic era starting with the Volcker shock the “Great Moderation,” describing it as characterized by long business-cycle expansions and muted recessions. Enjoying “central bank independence” from the volatility of democratic politics, the Fed ensured economic stability, preventing a true bottoming out of the economy. But it is a stability that has rewarded wealth over work.
In the 2000s, speculative finance capital found a new asset class to rush into: homes. President George W. Bush called it the “ownership society,” and it was the one genuine attempt in this era to spread the benefits of an economy that rewards wealth to a broader class of Americans, through the popular extension of mortgage debt. Of course, it came crashing down in 2008.
And instead of using the moment to rethink American capitalism, making it work for more people, the Obama administration watched the Fed inject trillions of dollars into financial markets — benefiting lenders, not homeowners.
As a result, the post-Great Recession expansion looked like the earlier expansions in the Great Moderation. Asset prices rose first for the wealthy, while pay gains for most workers trailed behind until close to the end of the business cycle, not long before the next crisis struck — in this case, the coronavirus.
In the spring, the Fed drastically slashed interest rates and ultimately threw the largest-ever single wall of money at the economy, $3 trillion so far, buying up financial assets, including for the first time private corporate debt. Defying gravity, asset prices snapped back, while jobs and incomes suffered for many, underscoring the increasingly vast gulf between the economies of wealth and work that has arisen since 1980.
It is now clear that the Great Moderation is in fact a Great Repetition, regardless of which party controls Washington. When crisis strikes, the Fed staves off the worst consequences, only to bring back the same old song, playing on repeat.
Democracy has suffered as a result. Ordinary people have little voice in the policies that most dramatically affect their economic lives. Unaddressed problems, such as economic inequality, only contribute to political frustration and alienation.
“The cure for the ailments of Democracy is more Democracy,” wrote the philosopher John Dewey. More democracy is the cure for the ailments of capitalism, too. Rather than bailouts for the wealthy in moments of economic crisis, the key is to transform investment patterns from the outset. After all, history shows that government interventions are what reshape economies — whether it was the abolition of slavery after the Civil War, the New Deal or the Volcker shock.
Bold public investments are crucial and today are among the most widely touted economic policy ideas. The Fed’s asset-purchasing programs, so dramatically scaled up during the coronavirus pandemic, could be made more accountable to Congress and the people it represents. This would enhance the odds of their benefits being channeled more toward ordinary Americans.
Better yet, managing price inflation could be left to the Fed, while Congress and the executive branch could seize the reins of public investment. Legislators could revive the Reconstruction Finance Corporation (RFC) of the 1930s and 1940s. It was a government agency that leveraged public finances to make a score of ultimately self-financing public investments during the Great Depression and World War II. A new RFC was something Volcker — who was later critical of the economic patterns he had helped to launch — called for after 2008, but to no avail.
The coronavirus-caused economic crisis, at least, has starkly revealed the essential truth that the U.S. state has enormous financing power. Money and credit being scarce is a political choice only. Anything worth doing can be financed. Greater economic democracy is possible.
But to achieve it, elected officials must act more daringly than they have in the recent past. The Biden administration’s proposed $1.9 trillion economic rescue package is a welcome start. Treasury Secretary Janet Yellen, ironically a previous Fed chair, has implored Congress to “act big.”
It should, otherwise the Biden administration will preside over the next chapter of capitalism’s Great Repetition, while its calls for democratic renewal ring hollow.