Economics, Finance and Crisis
There is a popular cliché that the political right sticks together to support ‘right’ causes while the left tears itself apart over internecine squabbles. The challenge back is that there hasn’t really been a left to speak of in the US for the last thirty-five or so years. Undoubtedly there have been a lot of people fighting the good fight from left perspectives. But the face of the left put forward in public debates has been of center-right actors playing politicians and economists to push ideas and policies in sync with the interests of the rightward-moving social order— hegemony in Antonio Gramsci’s explanation of social apologetics. The problem today is that these ideas and policies are to some fair extent responsible for current circumstance. When self-described liberal economists like Paul Krugman pushed the antique contrivance of ‘comparative advantage’ to legitimate ‘free-trade’ policies, including outsourcing Western jobs to low wage countries, their public posture as compassionate liberals effectively sold the idea to people who trusted them but who may have failed to understand the economics. Similarly when Democrat Presidents sold bank deregulation on the basis of economic ‘efficiency’ and bank bailouts to ‘save the economy’ they added liberal ‘legitimacy’ to economic ideas that the radical right could not have effectively sold only a generation before.
Graph 1: The rise in income inequality is closely related to the rise in financial asset prices. Implied is that the mainstream economic ‘savings’ model misses a host of relationships including financing and the ability of corporate executives to enrich themselves through granting stock options.
This latter point has relevance as Mr. Krugman tries to retain the hold of the radical center on economic policy as circumstances move rapidly beyond its purview. The problem is that ‘we’ are now thirty plus years into implementation of the trade and market economics the radical center has been promoting. The West has seen one of the ‘purest’ experiments in radical capitalist economics ever undertaken, or even practically possible, and the result is societies and the environment in rapid decline, the creation of a world where conspicuous wealth meets its match in social dysfunction and poisoned air, water, land and food and by degree social holocaust from global warming. No one person is responsible for broad historical epics like that of the present. But there comes a time when these epics either depart or they take their world down with them— think of the failed regimes of the twentieth century responsible for human tragedy theretofore unimagined. And the social apologetics that supported them are in hindsight the improbable delusions of people who should have known better— phrenology, eugenics, unregulated finance, really? Really? (See Ian Fletcher’s ‘Free Trade Doesn’t Work’ for a mainstream takedown of the related ‘comparative advantage’).
Graph 2: With income inequality related to financial asset prices, the question becomes: are these prices at reasonable levels? In other words, is there an economic ‘basis’ that relates the economic contribution of the rich to their wealth? Using Robert Shiller’s corporate earnings and stock price data, US stocks have been in a bubble since the mid-1990s meaning that prices are largely unrelated to economic contribution. And even this view leaves aside the effect of low interest rates in boosting corporate profits, the denominator in the price-earnings ratio. ‘CAPE P/E’ uses cyclically smoothed earnings through a 10-year moving average.
The straw man put forward as dividing line by Mr. Krugman in his challenge to ‘heterodox’ economics is ‘prediction’ of the financial crisis of 2008. In fact, the crisis on Wall Street was but a manifestation of the radical economic dysfunction it, and finance capitalism more broadly, has inflicted on wide swaths of the peoples of the West for some decades now. And the failure of the economic mainstream lies in the economic frame that only sees what it expects to see— a deductive method that favors internal coherence over social relevance. Without incorporating the role of modern finance in the global economy the mainstream that Mr. Krugman seeks to defend served, and continues to serve, as effective foil against possible resolution. While there was near universal support for fiscal policies to support ‘the economy’ on the economic left (for a variety of Keynesian and Marxian reasons), including from Mr. Krugman, it is not at all evident that the standalone monetary policies undertaken by the Federal Reserve that he supported have done much more than revive the financial economy of Wall Street.
Framed differently, the demand-side policies the liberal mainstream continues to push are but so much wishful thinking until the system of international finance is resolved. It isn’t just that income ‘inequality’ is coincident with the growth of finance capitalism; it is by and large caused by it. A reasonably coherent explanation of the global financial imbalances behind the financial part of the ongoing economic crisis from the BIS (Bank of International Settlements) wastes time addressing the liberal mainstream’s ‘saving’ versus financing theme because it is used to claim understanding of finance that evidence to date suggests simply doesn’t exist. But the real problem is right now, in the present: by focusing on aggregate demand while leaving the system of global finance intact, Mr. Krugman’s economics remains but a Mr. Fixit, a ‘useful idiot,’ for the financial plutocracy that cares not what destruction it causes because it is both immune from adverse social consequences and it is institutionally / constitutionally incapable of understanding its role in causing them.
Graph 3: Financial asset prices become inflated relative to the underlying economy through leverage. Margin debt is money that is borrowed to buy financial assets. The more prices are leveraged the greater the depth and breadth of the financial crisis that follows when prices inevitably fall. Excessive leverage was behind the stock market crashes of 1929 and 2008. In fact, margin debt is but a tiny portion of the systemic leverage that Wall Street and the Federal Reserve have recreated since 2008. Part of why margin debt and stock prices are so closely related is technical with required margin based on a ratio. However, this has no bearing on the effect of excessive leverage.
The point has been argued by a number of New Keynesians that it is the economic effects of the rise of finance that are behind the shortfall in aggregate demand responsible for current economic weakness. Wall Street created a housing bubble that pulled housing demand forward goes the logic. Subsequent overbuilding led to an inventory overhang that is lessening housing’s contribution to economic growth in the present. While this view requires no model of finance because it deals with consequences rather than causes, its leaves resolution in the same place that Mr. Krugman has left it— with Keynesian prescriptions that government step in with fiscal support when it is wholly evident that this will not happen and with the unidentified cause of sequential financial bubbles, Wall Street with the support of the Federal Reserve, fully restored. With the epic of finance capitalism of the last thirty years largely responsible for growing income and wealth ‘inequality’ and the sequential financial crises taking increasing toll on economic outcomes, the question back is: why treat the symptoms without addressing the cause? The first financial recession in this epic occurred around 1990 and it carried with it the first ‘jobless recovery.’ The causes were more than ‘just’ finance— they were tied to the labor market effects of outsourcing that lay at the heart of New Keynesian ‘trade’ models. It is no accident that ‘liberal’ economists supported the DLC’s (Democratic Leadership Committee’s) move toward liberal- free trade ‘synthesis.’ And While Mr. Krugman has long asserted that ‘more should be done’ to help those who have been displaced by his economic policies, the entirely predictable outcome is that little to nothing has actually been done. As with the income ‘inequality’ that has come from the corporate-finance nexus, New Keynesians have been willing fronts for a corporate-financial coup that never intends to give anything back, ever.
Graph 4: Interest rates are the ‘price’ of financial leverage. The lower that interest rates are the cheaper financial leverage is. Federal Reserve interest rates policies lead longer-term interest rates higher and lower. Since the onset of financialization in the 1980s both nominal and inflation adjusted Fed policy rates have been sequentially lowered to support increasing financial leverage. Mainstream ‘savings’ based economic models can’t account for financial leverage and asset price inflation. This leaves mainstream economists supporting monetary policies that lead to financial bubbles and destroy the ‘real economy.’
In contrast to mainstream theory, runaway finance has real economic impact. The second finance related recession in the early 2000s led to the second ‘jobless recovery.’ The mainstream explanation typically put forward is that it was the currency exchange rate, the ‘overvalued’ dollar, which was responsible for weak employment. However, the financial flows that led to overvaluation were largely from Europe and were the result of the developed West chasing financial returns on Wall Street. (See the BIS paper link above for further explanation). The overvaluation had little to do with trade ‘imbalances’ as the mainstream storyline has it. The housing bubble began around 1998 and its financial dysfunction was securitized by Wall Street, which includes major German and French banks, and was distributed broadly across Europe and the developed West. Outsourcing was only a partial cause of labor market woes with manufacturing employment in decline. But median wages had been declining for twenty years prior. And outsourcing was closely tied to finance through corporate ‘restructuring’ that gave profitable companies the ‘incentive’ to end institutional ties with labor that built the Western economy in favor of the false imperative that Western industry earn finance-like profits when financial profits were a house of cards about to come crashing down. So sure, accounts of economic events can be given that exclude the role of finance, but why would anyone looking for honest explanation want to do so?
Graph 5: The question of how inflated stock prices find their way into corporate executive ‘paychecks’ has been unduly mystified. Since the late 1980s executives and captive Boards of Directors have granted massive quantities of stock options to senior executives. Financial asset price inflation caused by increasing financial leverage has raised the value of these stock options as it has raised the prices of nearly all financial assets. Executives have benefited from financialization as corporations have benefited from cheap leverage due to low borrowing costs. These low borrowing costs inflate corporate earnings suggesting that Fed Policy has distorted the entire economy.
Current circumstance is of Western economies emptied out by thirty years of looting from connected insiders. Dean Baker has written at length about the phony ‘market’ for corporate executives that is an insider’s game of Boards of Directors beholden to the executives they are in theory tasked with overseeing. The line taken from Saez’s and Piketty’s income distribution data claiming that ‘executive compensation’ is the major reason for increasingly skewed income and wealth distribution ignores the role of Wall Street and the Federal Reserve in inflating the value of the self-granted stock options that are part and parcel of this looting. The record corporate debt illustrated in Graph 6 below was borrowed at interest rates held down by Fed policy and is being used by corporate executives to buy back company stock thereby raising the share prices that are the basis of the value for the stock options that they have granted themselves. Additionally, a major contributor to stock returns over the last century, stock dividends; have been used for the same purpose. The ‘dividend yield’ of stocks is a fundamental measure of valuation and as illustrated above in Graph 5 above, dividend yields have been far below their historical average since the mid-1990s. The combination of stock price inflation facilitated by interest rates held down by the Federal Reserve and corporate profits likewise inflated through cheap, abundant debt and a full-blown lootocracy amongst Western executives has the economic mainstream scratching its head over some great mystery of the universe that is reasonably straightforwardly explained as coordinated looting. Again, mainstream economists can call looting ‘compensation’ if they want to, but why do they want to?
Graph 6: Much has been written in the mainstream press about financial de-leveraging since Wall Street and the Federal Reserve killed the economies of the West in the mid-2000s. Some of the leverage on leverage known as ‘shadow banking’ was put on temporary hold due to the implausibility of ‘securitization’ in the immediate aftermath of the financial meltdown of 2008. But this view of de-leveraging conflates financial crises with the persistent burden that excessive debt places on the broader economy. While mortgage debt outstanding has flattened some since 2006 corporate debt has taken up the slack leading to the combination of mortgage and corporate debt being greater today than it was when excessive debt began to sink the economy in 2006.
This current epic of finance capitalism will either be resolved in disorderly or catastrophic fashion but it will come to and end. By design it is too deeply embedded in broad political economy for orderly resolution to be a high probability. The economic mainstream that wants to stay relevant should ‘fess up to its role in current circumstance and admit that it knows little to nothing of what to do about it. What is wholly evident in retrospect is that the powers that be took what it wanted from the liberal economic mainstream with no intention of assuaging the economic dislocations that antique-revival trade policies were sure to produce. Nonsense about the problem being a failure to predict the financial crisis of 2008 requires dissociating it from those of the early 1990s and early 2000s and the associated economic dislocations broadly considered. The common link is finance. At this point in history empty blather about income ‘inequality’ that fails to address the role of finance looks a lot like determined misdirection.
Rob Urie is an artist and political economist. His book Zen Economics is forthcoming.