In the Time Between Crises
The working premise of politicians and economists in the ‘developed’ world of the West is a basic economic stability has been achieved by way of the depth and breadth of the political-economic institutions created over the last 75 years. The storyline coming out of Washington, London and Brussels is of degrees of economic ‘recovery,’ if halting, from the Great Recession. But missing are the institutions on which stability was based. They were removed in recent decades in favor of ‘market’ based reforms. What remains are institutions—the political establishment and the Federal Reserve, that support and foster the worst excesses of unfettered capitalism. This suggests periods of economic ‘recovery’ are now whatever lies between the periodic crises endemic to capitalism. To be clear, this isn’t a forecast. It is more nearly a look at history with and without the institutions of ‘managed’ capitalism to infer likely outcomes.
By mid-2006 news stories began appearing that a large percentage of mortgage loans made in the preceding few years were ‘no-doc’ or ‘stated income’ and investigation had revealed actual incomes were far less than the amounts stated on loan documents. The practical implication was a lot of people had bought houses they couldn’t make the loan payments on. As subsequent evidence revealed, in many cases loan officers had determined the ‘stated’ income amounts to be filled in on the loan applications by solving for the amount needed to qualify for the loan. The mortgage brokers making these loans and the Wall Street banks securitizing them were ‘earning’ fabulous sums in commissions, wages and bonuses, but the business was unsustainable—not only did it not continue, it set into motion the greatest economic catastrophe since the Great Depression.
From 2006 well into 2007 there was little sense of impending catastrophe. A number of economists who were paying attention understood the risks and set about ringing the alarm bells. But the alarm bells went unheard by the powers that be in Washington and New York. Fed Chairman Ben Bernanke echoed the Wall Street line there hadn’t been a nation-wide decline in real estate prices since the Great Depression. When crisis finally struck establishment reactions took two tracks. The first from the George W. Bush and Barack Obama administrations was to restore the financial system to its pre-crisis state through bailouts and ongoing subsidies. This was accompanied by modest efforts to offset the consequences of the crisis in the ‘real’ economy with economic stimulus. The second track was to recognize the failure of mainstream economists to ‘predict’ the crisis and to look further back in time to ‘depression economics’ for solutions to its economic consequences, but not its causes.
Fast forward to today and the ‘new’ mainstream economic debate centers on ‘austerity’ versus economic stimulus to fix the still ailing economies of the West. The Keynesian solutions being offered—increased fiscal stimulus to increase ‘demand’ and support for embattled Fed Chair Ben Bernanke’s monetary stimulus, assume away the causes of crisis as either irrelevant or no longer in place. But in earlier history Mr. (John Maynard) Keynes’ solutions to economic depression were implemented in conjunction with a broad set of restrictions on the system of finance capitalism. The current argument for Keynesian stimulus places the broader institutional changes that supported Mr. Keynes’ economics outside the realm of its concern. But in practical terms, no economic ‘lessons from history’ from Keynesian economics can be derived in isolation from the broader policy context in which they were enacted.
The two reasons mainstream ‘New’ Keynesian economists avoid addressing the broader context is in the first place they have no context for broader context—the purposeful irrelevance of the profession quickly becomes apparent when the broader institutional context (laws, regulations, governing institutions, competing interests etc.) is determinant of economic outcomes because it resides (way) outside of the mainstream economic realm of concern. The second reason is implementing actual solutions requires taking a critical look at the ‘meta’ context of capitalism itself. Put another way, were a leading ‘liberal’ economist able to implement his / her wish list of fiscal stimulus it would do little to stabilize the system of finance capitalism. And by avoiding the larger issues Keynesian economic ‘patch’ jobs facilitate the next spectacular catastrophe. In fact, modest Keynesian patches have been applied during recessions in the recent decades of the ascendance of finance capitalism and its associated crises keep getting worse.
The response of the liberal economic mainstream at present is as follows: financial bubbles, whatever their causes, may be contributing factors to economic crises; there are no financial bubbles evident at present, therefore the correct response of economists is to push for fiscal and monetary stimulus to address the still weak economy. The (unstated) historical context is there were no financial bubbles in the U.S. between 1935 and 1980, the approximate period in which Mr. Keynes’ economic prescriptions were coincident with institutional safeguards against them, and they have been regular occurrences of increasing severity since then. What changed is the broad set of institutional safeguards that prevented financial bubbles were removed beginning around 1980. But the safeguards weren’t directed at stopping financial bubbles per se—they were designed to restore the broad social function of capital allocation to the financial system.
Even this version of events greatly understates the breadth of the institutional context in which these recurring crises of increasing intensity are now occurring. Coincident in recent decades with the financialization of the economy has been a shift in the distribution of the product of labor to capital and finance, the diminishment of labor’s bargaining power, a shift in tax burden from finance and property to labor, and increasing efforts to cut government expenditures so that even more resources are shifted toward ‘private’ wealth accumulation. Liberal economists pose it as a mystery why Barack Obama wants to cut Social Security and Medicare. But Mr. Obama and these liberal economists subscribe to the same economics. If the increasing concentration of wealth from public and ‘private’ sources is internal to capitalism as a political-economic system, then Mr. Obama promotes the causes of systemic instability that Mr. Krugman responds to with Keynesian economic patch jobs. But by supporting the broad system, Mr. Krugman also supports the causes of systemic instability.
The base argument made here and by (many) others is capitalism is a system of economic aggregation. Finance capitalism is a particular form of economic aggregation. Capitalists argue this aggregation is ‘capital formation’ and a good thing because it facilitates investment that leads to economic growth. The paradox long recognized is that without being managed, as in the broader institutional context of Mr. Keynes’ economic policies 1945 – 1980, capitalism cooks its own goose—economic concentration leads to political-economic instability. Recent historical evidence has it that when capitalism was managed 1945 – 1980 it was stable and in the time it hasn’t been managed 1980 – present it hasn’t been stable.
Ironically, it was the residual concentrated wealth of ‘managed’ capitalism that facilitated the revival of unmanaged capitalism. In the 1960s political economist Robert Heilbronner wrote of the 10:1 ratio of senior management to worker pay and the high residual concentration of wealth. It was this political economy that eventually brought the resurgence of finance capitalism with the elections of Ronald Reagan and Margaret Thatcher. A decade and one-half earlier a group of right-wing millionaires began funding economic ‘think tanks’ to provide intellectual foundations for the re-ascendance of unfettered capitalism. By the mid 1970s their efforts bore fruit as President Jimmy Carter began dismantling the regulatory structures descended from Franklin Roosevelt’s institutions created to tame capitalism. The purposes were new—environmental and workplace safety regulations, but they were responses to the inability of capitalism to clean up its own messes. Mr. Reagan and Ms. Thatcher built on these deregulatory (de-institutionalization) efforts and ‘freed’ finance to facilitate the full-blown resurgence of unfettered capitalism.
Jump to the present, one of the supports for the argument financial assets aren’t in another Federal Reserve driven bubble is the ‘price – earnings’ ratio of corporate earnings to stock prices is within historical norms. Left out of this formulation is the ratio of corporate earnings to the wages of labor is the highest in modern history—corporate earnings are through the roof while the wages of labor have fallen (relative to what labor produces) and continue to do so. And the bloated earnings of corporate executives inflate even these falling wages. What is illustrated is the tendency of income and wealth to become narrowly concentrated in ‘unmanaged’ capitalism. The rich are getting richer because everyone else is getting poorer—the difference is causally linked. In a narrow sense this suggests the stock market may be at a level where is has historically been stable. But the broader system of finance capitalism that supports it appears to be unstable at an increasing rate. The narrow view gives no indication of the instability found in the wider view.
This ties to the current debate over income ‘inequality’ as a cause of economic instability. The economic backdrop is over a decade of slower overall economic growth as the rich have taken an increasing share of economic production. The mainstream argument is the overall rate of economic growth is unrelated to the relative concentration of income and wealth, hence economist Paul Krugman can argue economic stimulus will benefit ‘the economy’ without addressing income distribution. But in American (and most European) history in recent decades inequality and economic instability have been coincident. This isn’t to argue ‘inequality’ is destabilizing, but rather that inequality and instability are both aspects of the unstable system of (finance) capitalism. The tendency toward wealth and income concentration were artifacts of finance capitalism before Franklin Roosevelt and Mr. Keynes ‘saved’ it by instituting meaningful controls and have been artifacts of finance capitalism since those controls were done away with. In between were periods of economic stability and relatively low levels of income inequality. History has it the institutional controls that provided systemic stability reduced income and wealth inequality, not the other way around.
Were the broader system of capitalism stable, Keynesian solutions to current economic woes would make sense. But the rejection of Keynesian policies and the ascension of austerity across the West have joint cause. The illusion that policy ‘debate’ is behind this outcome illustrates the inability of modern economists to address the social phenomena behind economic policy decisions. Austerity benefits the ruling class by shifting economic resources from government to the ‘private’ sector where wealth concentration occurs. Apparently well-meaning economists like Mr. Krugman are dumbfounded that Keynesian policies that produce more output than they require in government resources, ‘free- lunch’ as they put it, don’t become implemented policy. But the ruling class that capitalism has installed through income and wealth concentration demonstrably couldn’t care less about this free lunch because shifting resources from labor and government to their pockets is their free lunch. Conversely, with the ‘failure’ of austerity much in evidence, where exactly are the policies from Washington, Brussels and London that suggest the fiscal stimulus Keynesians argue we need is part of any relevant consideration?
What then is the evidence of future instability on the horizon? Most of it is hidden out of sight in financial assets—various incarnations of derivatives and asset ‘containers’ like ‘SIVs’ (Structured Investment Vehicle) Wall Street banks continue to create. Whereas Credit Default Swaps are intrinsically destabilizing because they provide strong incentives for absolute economic destruction via multiple insurance policies on single assets, the financial system itself is intrinsically destabilizing through cross-liabilities. Of the approximately one-quadrillion dollars of Swaps notional outstanding, the economic consequences of one bank defaulting on even a relatively small proportion of its liabilities is multiplied to massively destabilizing proportions. More down to earth, the compensation investors receive for default risk; the yield on ‘high yield’ corporate bonds (less the risk-free yield) has been driven so low by Federal Reserve policies it doesn’t provide adequate compensation for default risk. This will cause significant ‘forced’ sales to meet mutual and pension fund redemptions in the next inevitable default cycle. The stock market is wildly overpriced when CAPE (Cyclically Adjusted Price – Earnings) is used in the market ‘price-earnings’ ratio instead of short-term earnings. The reason why CAPE provides the better measure is corporate earnings have historically moved over and under an average rate (mean revert) and the current level is very far above this average.
Back to the home mortgage debacle: the argument today is over-leveraged households led to widespread defaults on home loans that led in turn to the financial crisis and its repercussions. Today households are said to be less leveraged than they were in the lead-up to the crisis and are continuing to pay down debts. However, household leverage is measured by the intersection of the amount of debt a household has and its capacity to pay. The use of aggregate economic data by mainstream economists hides the degree to which incomes have fallen for most households because executive and financial compensation skews aggregate wage data higher. U.C. Berkeley economist Emmanuel Saez’s data shows incomes for 90% of Americans fell in 2008 and have yet to recover. To the extent poorer households borrowed more relative to their incomes and saw their incomes fall more relative to wealthier people’s (they did) means lower levels of household debt have ambiguous bearing on household leverage. To the extent people have diminished capacity to pay their debts (debt deflation), lower debt levels don’t necessarily mean lower household leverage. Add in the residual fragility of the financial system and the class struggle evidenced in income ‘inequality’ ties directly to the systemic instability of finance capitalism. Put another way, unless one posits a reversal in the trajectory of income distribution, most Americans face diminished capacity to pay debts even if the absolute amounts of debt also fall.
If Keynesians could get material fiscal stimulus implemented perhaps some of the case I’ve argued here might be diminished. But that is the point—material fiscal stimulus is nowhere on the horizon and despite gloating by Keynesians about being right that austerity is economically contractive, austerity is still official policy in the U.S. and Europe. So again, the ‘debate’ isn’t a debate at all—the ruling class wants austerity to transfer wealth from government to their pockets and austerity is what we have. The Ivy League Keynesian contingent can continue to have their egos soothed with phone calls from the White House but that does little to suggest their economics aren’t an effete hoax—they might be right if they could get their policies implemented but they can’t. For everyone else Marx and Lenin are the new go-to political economists, not because I say so but because the ruling class does.
Rob Urie is an artist and political economist in New York.