The Democratic Regime
To defend, as I will be doing, the proposition that democracy is politically skewing the financial markets is to assume that the prevailing form of government largely dictates what happens in society. It is to side with Aristotle, and indeed every other philosopher who thought about the human condition up until the emergence of sociology and economics in the nineteenth and twentieth centuries. Aristotle gave us a classification of regimes that still enables us to make sense of the variety of states. He distinguished the alternative regimes into three basic kinds: a state may be run by a single individual, an elite few, or many persons. Out of this tripartite division, Aristotle also differentiated the regimes based on whether the ruling element promotes the common good or its own interests. Accordingly, where a single person rules, the regime can be a monarchy or a tyranny; where an elite holds control, an aristocracy or an oligarchy; and where the many run the state, a polity or mobocracy. With a few exceptions, most of the governments within which the world’s leading financial markets operate fall under the third category. Even so, at least for definitional purposes, it is best to avoid being snared into the contentious matter about the extent to which popular rule actually maximizes the public interest. Thus, I will follow current practice and simply call that regime democracy in which the many rule. In other words, the political context of high finance today is a system in which the majority ultimately decides, from a menu of competing parties and coalitions vying for their votes, how the greater society is to be governed.
A few qualifications are in order. Nowadays, the many do not directly craft, approve, much less enforce laws and policies. Instead, they periodically choose representatives to perform these tasks on their behalf. Financial markets exist alongside representative, rather than participatory, democracies. Needless to say, this opens up the possibility that majority preferences will not necessarily get reflected in the government’s actions. Indeed, as I shall go on to observe, representative democracies are quite liable to capture by narrow, well-organized interests in numerous policy areas. The regulation of financial markets is no exception. Limiting the majority, too, is that individuals hold a set of rights against the government. Among these rights are property, privacy, equal treatment, and freedom of speech. A greater than 50 % tally cannot override these rights except under special conditions. In other words, contemporary democracies are liberal democracies.
Nothing is more important than this to understanding the political-financial nexus. Alexis Tocqueville—that keen nineteenth-century analyst of the American republic whose magnum opus Democracy in America I will occasionally draw upon in this book—observed that the animating principles of democracies are freedom and equality. As Tocqueville well predicted, the inevitable tension between these two values tends to break in favor of equality. This commitment to equality, as we shall see, manifests itself in numerous precincts of the financial markets. For example: the government’s prohibition of insider trading; the growth of the sub-prime mortgage sector that spawned the financial crisis of 2007-2009; the growth of welfare states intimately linked to bond markets; as well as the existence of a huge and paternalistic regulatory structure. Democracy also accounts for why the gold standard no longer exists, and why its return is hard to fathom. Democratic governments, as we shall see, have strong incentives to hand discretionary authority over the money supply to a central bank unencumbered by a gold-based constraint. Ever since this handover was consummated in 1971, the upshot has been heightened market volatility—to which we owe, in turn, the incredible, though regrettable, rise of the derivative markets since the 1970s.
Now, in adopting an Aristotelian regime approach in this book, I recognize the necessity of nuance and qualification. The nature of the polity cannot explain everything. People’s cultural preferences, historical experience, religious beliefs, and relative wealth are also taken into account here. One factor in particular that I will focus upon is people’s status as either taxpayers or tax consumers. Those who receive less in benefits from government than they contribute, we may call taxpayers; whereas those who receive more in benefits than they contribute, we may call tax consumers. Among the core arguments I make in this book is that the taxpayer versus tax consumer dynamic tends to end up augmenting and privileging the latter group at the expense of the former as governments expand the array of goods and services offered to the public. Taxpayers, however, do not passively accede to demands that they fund this largesse. In order to allay this opposition, democratic politicians find it very convenient to rely on the tandem of central banks and bond markets: whereby the first is empowered to create money at will to pay a portion of the state’s expenses and the second is disposed to lend money to the government. Financial markets have often been assailed for limiting the state. The truth is that, at least until the country’s debt capacity is finally breached, the markets are very much the adjutants of the state. With respect to the democratic state, the bond markets in particular serve as enablers of that regime’s congenital vulnerability to fiscal profligacy.
One cannot end this introduction to the forces at the intersections of politics and finance without referencing the international dimension where governments relate to one another. Once embarked on this scene, one comes across several non-democracies tied into the world’s capital markets—China now principally among them—and comes to further appreciate the aforementioned point of how decisive the nature of the existing regime is in shaping the political-financial nexus. By virtue of its authoritarian government, China can do things in the FX markets to control its currency that democracies cannot. The prices set in those markets are the most common points of financial contention among states, affecting as those do the competitiveness of a nation’s exports, the threat imports pose to domestic firms, the relative attractiveness of foreign direct investment, and the balance of payments.