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Money Before Liberal Democracy

“Follow the money”—ever since Watergate, that is the rule that journalists have been enjoined to follow in trying to unearth political scandals. It is no less valid a rule in trying to explain the politics of financial markets. Money is to the securities traded there what atoms are to the material objects around us—namely, that out of which such things as bonds, stocks, foreign currencies, and derivatives are made of. Go to the pages of any standard textbook in finance and one will see this fundamental reality. It is expressed in all the equations detailing how each of those financial instruments can be theoretically reduced to a series of cash flows over time. Whereas money is normally only on one side of the trade in our everyday dealings, it is effectively on both sides in the financial markets. There, present money is exchanged either against future money or another present money.

Underlining the centrality of money in the politics of financial markets is a historically distinctive feature of our monetary system. In a long process that was only consolidated in the twentieth century, governments nowadays do not merely certify that certain pieces of metal and paper it manufactures constitute money. Their central banks sit at the foundations of credit systems that literally create and destroy the stuff. The resulting fluctuations in the money supply affects the wherewithal that exists to purchase financial assets. Those fluctuations also impact the economy whose direction markets are incessantly seeking to divine. No wonder that central banks are watched closely by a phalanx of analysts parsing every word uttered by the head of the US Fed or the ECB. Indeed, few © The Author(s) 2017

G. Bragues, Money, Markets, and Democracy,

DOI 10.1057/978-1-137-56940-0_2

conclusions emerge more clearly from the scholarly literature than the fact that changes in monetary policy—especially those that are unexpected— represent a significant driver of stock, bond, and currency prices.1

Recognizing this, portfolio managers widely follow investment strategies based on what the central bank is doing. A common rule of thumb is to hold a higher proportion of stocks relative to cash when the Fed is loosening monetary policy. Conversely, whenever the Fed is tightening, the same rule counsels a shift away from stocks toward cash. Not content to be merely passive observers, however, investors and traders have also been known to urge the Fed to act in times of market stress. The most notorious instance of this occurred when signs of a freeze in the sub-prime mortgage market first began to appear in August 2007. While appearing on CNBC, Jim Cramer, an ex-hedge fund manager and a host on the network, suddenly went into a tirade imploring the Fed to relax monetary policy, screaming that “they know nothing”.[1] [2] Central bankers have not always responded to such pleas. But they have not outright ignored them either, always paying special attention to market signals in such circumstances.

As the twentieth century progressed, the predominant view of this relationship between the world’s central banks and financial markets came to reflect a Hegelian end-of-history spirit. By the beginning of the twenty- first century, this spirit had crystalized into a monetary version of the thesis that Francis Fukuyama posited for the Western world as a whole.[3] Fukuyama claimed that humanity had reached the apex of political reflection in finally realizing that liberal democracy is the best regime. Similarly, economists reckoned that their discipline had progressed to the point of finally figuring out how to optimally address the question of money. Throughout history, societies have been perpetually bedeviled by the opposite evils of too much and too little money. The first evil gives rise to a socially destabilizing inflation, the second to a depression-inducing deflation. But now, supposedly, the historical riddle was solved. The answer: a government-backed monopoly supplier of money, otherwise known as a central bank. So long as its decision-makers are kept independent of the day-to-day political process, a central bank has come to be thought as best advancing the functioning of financial markets. Such a bank can support the conditions under which the public can find solid investment opportunities and deserving firms can obtain capital. In this way, so the argument goes, the state’s regulation of money and the operation of the markets combine to promote economic growth in an environment of overall price stability. The apotheosis of this view, its owl of Minerva moment as it were, came with the widespread acceptance of the “great moderation” thesis just before the 2007-2009 financial crisis. According to that thesis, the leading Western economies had finally succeeded in reducing economic volatility while maintaining growth. This was said to be due, in no small part, to the successful implementation of inflation-targeting strategies by independent central banks.[4]

No doubt, real differences of opinion continue to exist about the central bank’s role in managing the money supply. As in foreign policy, there are doves and hawks proposing clashing approaches to monetary policy. The doves prefer low interest rates and a greater circulation of money. They think that promotes employment and growth. The hawks, meanwhile, lean toward higher interest rates and a smaller quantity of money. They think that will prevent inflation. But neither party disagrees on the core principle—to wit, that money is the sole prerogative of the state and that, as such, the state is entitled to exercise control over money without hindrance from any power beyond it.

When it comes to money, we have been given a Whig narrative of history. A scientific approach, we have been told, has evolved to conquer the money dilemma. The reality, though, is that the current monetary system reflects the beliefs, power dynamics, and normative imperatives of democracy. The structural framework by which central banks operate in tandem with financial markets is not so much the pinnacle of economic rationality as it is the sort of arrangement that one would expect in a democracy. This does not mean that there is nothing reasonable in our monetary order. It is merely to say that, like any dominant social and ideological force, democracy can bias thinking, leave key assumptions unexamined, and obscure historically tested alternatives. In this instance, our liberal democracies have encouraged an excess politicization of money.

To better comprehend how modern democracy has exercised this decisive influence, we need to review the story of money up until that form of government began to emerge in the eighteenth century. This will allow us to isolate those monetary factors that persisted and changed with the onset and evolution of democracy. We will then be in a better position to identify how exactly popularly elected regimes impact the medium of exchange. This chapter is devoted to this preparatory task, setting us up for the discussion of liberal democracy’s relationship to money in the next chapter.

  • [1] See, for example, Ben Bernanke and Kenneth N. Kuttner, “What Explains the StockMarket’s Reaction to Federal Reserve Policy?” The Journal of Finance 60 (2005): 1221-1257;Roberto Rigoban and Brian P. Sack, “The Impact of Monetary Policy on Asset Prices”,Journal of Monetary Economics 51 (2004): 1553-1575; Thomas Urich and Paul Wachtel,“Market Response to the Weekly Money Supply Announcement in the 1970’s”, The Journalof Finance 36 (1981): 1063-1072; Jeromin Zettelmeyer, “The Impact of Monetary Policyon the Exchange Rate: Evidence from Three Small Economies”, Journal of MonetaryEconomics 51 (2004): 635-652.
  • [2] A video ofCramer’s rant can be viewed at:
  • [3] Francis Fukuyama, The End of History and the Last Man (New York: Free Press, 1992).
  • [4] Ben Bernanke, “The Great Moderation”, remarks given at the meetings of the EasternEconomics Association, Washington, DC, (February 20, 2004),
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