The Great Financial Crisis lingers. That the world economy continues to grow does not change that fact. There are different lenses from which one can view the crisis and seek to understand its implications.
We are drawn to a lens that was central to the political economic discourse from the middle of the 19th century through the Great Depression. It was the idea that capitalism was so terribly successful that it generated a surplus in excess of what it could profitably invest.
Charles Conant, a journalist-cum-presidential adviser in the late-1800s, and early 1900s recognized a limited range of possibilities. Anticipating Mad Men by half a century, Conant understood that increased consumption could absorb the surplus. There was a certain plasticity to consumer desires. Still wedded to the character-building concept of scarcity, Conant saw limitations to this course.
Conant realized the surplus could be redistributed. He accepted some movement in this direction but thought that too much would undermine the work ethic. Conant knew war could destroy the surplus, but he was not war-monger. He rejected this option on humanistic ground.
The alternative he advocated was to export it. However, he also recognized that the other industrialized nations faced similar "capital congestion". The US surplus could not go there, but rather it would directed toward the emerging markets of the era. Conant wanted the surplus capital to build infrastructure, including railroads. This would absorb the surplus savings and help integrate those regions via trade in goods and services.
The Great War destroyed tens of millions of people and the capital stock of Europe and Japan. The idea of surplus capital, a central thesis, moved to the margins of the economic and policy making circles. However, by the late 1960s and early 1970s, Europe and Japan were rebuilt, and the excesses began growing again. The cultural critique of the 1960s and the stagflation of the 1970s saw some interest return to the surplus capital lenses.
Reagan and Thatcher can be viewed through the lenses as turning Conant on his head. The export surplus only aggravated the general congestion in the world. Instead, the Anglo-American economies would absorb the world's surplus capital. This meant importing the world's products and capital. This meant current account deficits and capital account surpluses. This required the liberalization of the capital markets and financial innovation.
The Great Financial Crisis marked the end of that strategy of dealing with the surplus. There were political limits on how large of a trade deficit the US could run without triggering a protectionist backlash. Keeping the surplus out of production and into financial assets worked for the better part of two decades. The press for deregulation succeeded in weakening the oversight and the allowed the gaming of the system, while the financial engineering created complex, opaque and illiquid financial products, with incredible leverage and risk beyond comprehension. The Great Moderation not only reduced the magnitude and amplitude of the business cycle but also served to fan the belief that asset prices could only rise.
This side of the crisis, there is still too much capital. Much of the capital that was destroyed was recovered and/or redistributed. Modern representative governments (and many of those that may not be so modern or representative) are loath to follow Andrew Mellon's advice to Herbert Hoover: “Liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate.”
Seeing this through the liberal lenses or its close cousin neo-, some economists talk about secular stagnation and insufficient aggregate demand. The political program they advocate is boosting aggregate demand through the government-sponsored infrastructure, which is indeed needed in most of the high income countries, let alone the rapidly urbanizing moderate and low income countries.
However, it does not break the cycle. It will not solve the challenge of surplus capital. What good, for example, is another tunnel into Manhattan if the toll costs most than an hour's work at the average pay? Among the periphery in Europe, Portugal has among the most modern infrastructure, yet it has not boosted the country's competitiveness. China has spent billions on infrastructure, but the economy is maturing, and growth is clearly slowing.
The liberals are reformers. They think there is a problem with capitalism and it can be fixed by this program or that. They do not appreciate that the main challenge comes not from capitalism’s weakness but its strength. It produces wealth in such abundance that we are choking on it.
The end of the Reagan-Thatcher solution leaves us without a new strategy to deal with the surplus capital. It has given the body politic a fever. A fever is both a symptom of the illness and an attempt by the body to cure itself. That is what negative nominal interest rates are—a symptom of the surplus capital and a cure—namely the destruction of capital.
In order for society to continue, the social classes needed to reproduce themselves. Wages need not just to sustain an employee, but be sufficient to have a family. Capital needs to reproduce as well. This is the return on capital—interest rates and profits. Productivity gains are divided between wages and profits.
The lion’s share has gone to profits as wages have become decoupled from marginal gains in productivity. This forced women into the work force in droves. This still was not sufficient. Increasingly young people were forced into the labor market. This still was insufficient. Rather than win concessions from capital, the state interceded. The fastest growing part of household income comes from transfer payments. Nearly 20% of American households get government assistance for buying food. The rise in the minimum wage in over 20 states and cities this year is another concession from the state (which turns out to be among the largest employers, through contracted work, of minimum wage workers).
This still was not sufficient. Households took on debt to square the circle. The Great Financial Crisis ended that. The consumption in the US (4.3% increase at an annualized pace in Q4) is being done without much of an increase in revolving debt (credit cards). Now we have the first generation of Americans that most likely will not live as well as their parents. This is the way that the inability to reproduce itself is reflected among workers.
Capital is also finding it difficult to reproduce. Facing dismal returns, which Conant understood would be a consequence of capital congestion, capital has sought to increase further its share of productivity. This is one of the under-appreciated reasons why wages, even where the labor market is tight or tightening, like Germany, Japan, the US and the UK, are not seeing wage gains.
There is a political backlash against the concentration of wealth that has resulted. The political repulsion has many expressions and crosses the political spectrum. Capital is subject to the same laws of supply and demand that they insist for the production and employees. The negative interest rates are a prima facie case of too much capital.
The most famous equation last year was Picketty’s r>g. That meant when the return to capital was faster than growth, which historical tendencies showed, it led to a concentration of wealth. The negative nominal interest rates means that r<g. Negative interest rates turn capitalism upside down.
The crisis will linger until we find an answer to Conant’s question. What to do with the surplus capital that our political economy cannot help but generate. Picketty treated capital as synonymous with wealth. If we widen the definition and return it to its original meaning, it represents a social relationship. Ultimately to resolve the surplus capital problem, social relationships have to change by definition.
Negative Interest Rates: Capital's Reproduction Problem is republished with permission from Marc to Market