Archive for March, 2013
As I illustrated in a previous post, “a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings”. Therefore “what wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation”. The fact that our dominant macroeconomic policy doctrine depends upon the ‘wealth effect’ simply reflects the fact that our economy is driven by wealthy special interests.
The real question again is why there isn’t more mass opposition to such a blatantly regressive policy regime. In previous posts(1, 2), I have argued that crony capitalism achieves broad-based support by piggybacking upon broad-based programs aimed at the middle class. But they also achieve this support due to the absence of a safety net that breeds middle-class insecurity. This carrot-and-stick approach ensures middle-class support for the same stabilising policies that transfer wealth to the one percent. As the table below (taken from Edward Wolff’s paper) shows, the most significant asset holding of the middle class in the United States is their principal residence. The data is no different in the United Kingdom (table below from the ONS). Supporting house prices therefore is the sop that special interests need to provide to the middle class in order to ensure their support for the ‘wealth effect’-driven economy.
Although there are many instances of direct subsidies to middle-class households via cheaper mortgages (George Osborne’s latest policy being yet another example), these are dwarfed by the impact of the primary guiding principle of macroeconomic policy throughout the neo-liberal era – house prices must keep going up. Rising house prices don’t just act as a carrot to the home-owning middle classes. The fear of being left behind and being out priced by a rising market also acts as a stick to those who don’t own homes. Again, middle-class support for the crony capitalist plutocracy is driven by the stick as much as it is by the carrot. Those who “fear” that the latest housing scheme “risks driving up prices” should realise that the increase in house prices is not an unintended consequence but the primary aim of our crony capitalist policy regime.
In his book ‘The Rise And Decline Of Nations’, Mancur Olson argued that over time stable democracies will experience a progressive increase in the power and influence of special interests and crony capitalists. Olson also identified the self-preserving nature of this phenomenon. Once rent-seeking has achieved sufficient scale, “distributional coalitions have the incentive and..the power to prevent changes that would deprive them of their enlarged share of the social output”. Olson’s diagnosis was accurate on both counts. Most developed economies are currently stuck within various stages of Olsonian demosclerosis.
But Olson also believed that there were limits to just how much of a nation’s GDP crony capitalists could extract before public anger or social instability would rein them in. Olson was almost certainly too optimistic in making this argument. In an earlier post I explained how crony capitalists can avoid these limits by piggybacking upon progressive programs that are meant to help the masses. As I concluded, “The masses become the shield for the very programs that enable a select few to extract significant rents out of the system. The same programs that are supposed to be part of the liberal social agenda like Fannie/Freddie become the weapons through which the cronyist corporate structure perpetuates itself, while the broad-based support for these programs makes them incredibly resilient and hard to reform once they have taken root”.
A common feature of most crony capitalist economies is the pervasive presence of subsidies targeted at the middle class. Progressives often view middle-class subsidies as the unavoidable price required to secure widespread support for the welfare state. But in reality middle-class subsidies act as the carrot that aligns the interests of the middle class with parasitic crony capitalism. However, along with the carrot comes a very hefty stick – the absence of a safety net. The absence of a safety net that protects individuals against catastrophic outcomes breeds middle-class insecurity. The fear of falling through the cracks causes the middle class to support the very rent-infested programs and corporate bailouts that sustain the plutocracy. In the absence of a safety net, the middle class seeks safety in the safety of the incumbent firm that employs them. I have often described the neo-liberal era as the era of “stability for the classes and instability for the masses”. But the two are not independent. It is precisely the fragility of the masses that provides stability to the classes.
Government provision of a safety net is not just a matter of social justice. It is in fact a critical component of a free enterprise economy. Just as those on the left of the political spectrum need to appreciate the insanity of supporting a system that ties the security of the masses to the security of its incumbent crony capitalists, those on the right of the political spectrum need to, as Reihan Salam argues, “embrace the idea of a social safety net as an important element of a free enterprise economy, not just as an unfortunate accommodation to political reality”. An employer-independent safety net promotes free enterprise by enabling us to dismantle the privatised welfare state that is the lifeblood of crony capitalism. Only if we construct a safety net for individuals can we dismantle the hammock that incumbent crony capitalists in our economy currently enjoy.
The debate as to whether the Greenspan Fed’s easy money policies are to blame for the 2008 financial crisis tends to focus on the Fed’s actions after the bursting of the dot-com bubble in 2001. Some (like Stanley Druckenmiller) argue that the Fed should have allowed a recession and a “cleanup” while others such as Paul Krugman argue that it is ludicrous to tighten monetary policy in the face of high unemployment and low inflation.
The simplistic criticism of Greenspan-era monetary policy is that we should have simply allowed recessions such as the 2001 recession to play themselves out. In other words “let it burn”. But the more nuanced criticism of the ‘Greenspan Put’ school of monetary policy is not that it supports the economy, but that it does so via a monomaniacal obsession with supporting asset prices and hoping that the resulting wealth effect trickles down to the masses. I have made this point many times in the past as have many others (e.g. Cullen Roche).
There are many ways to support the economy and only our current system focuses entirely on bailing out banks and shoring up asset prices in exclusion to all other policy options. Why can’t we allow the banks and the market to fail and send helicopter money to individuals instead? Why can’t we start money-financed deficits and increase interest rates at the same time? By narrowing our options to a choice between ‘save everybody!’ or ‘let it burn!’, we choose an economic system that favours the 1% at all times. The Fed Kremlinologist extracts rents from the Greenspan Put during the times of stability and the sharks come out during the collapse1.
Krugman is correct in arguing that a recession is no time to stop the firefighting so that an asset market bubble may be prevented. But the original sin of the Greenspan era was not in triggering bubbles during a recession. It was in using monetary policy to support asset markets and the financial sector even when the real economy was in no need of monetary stimulus. The most egregious example of such an intervention were the rate cuts during the LTCM collapse which were implemented with the sole purpose of “saving” financial markets at a time when the real economy showed no signs of stress. Between September and November 1998, the Fed cut rates by 75 basis points solely for the purpose of supporting asset prices and avoiding even a small failure within the financial sector. Even a cursory glance at market events would have told you that the wider economy was in no need of monetary stimulus. Predictably, the rate cuts also provided the fuel for the final exponential ascent of the dot-com bubble2. This “success” also put Greenspan, Robert Rubin and Larry Summers on the cover of TIME magazine, which goes to show just how biased political incentives are in favour of stabilisation and against resilience.
The problem with the ‘Greenspan Put’ doctrine is not that it fails to prevent bubbles when a recession is on. The problem is that it creates conditions such that eventually there are only two states possible for the economic system – a bubble or a collapse. Market participants could assume that any fall in asset prices would be countered with monetary stimulus and took on more macroeconomic asset-price risk. They then substituted for the market risk they had been relieved of by the Fed with increased leverage. Rates of return across asset classes settle down to permanently low “bubble-like” levels except during times of collapse which are increasingly catastrophic due to the increased system-wide leverage. The stark choice faced by Greenspan in 2001, either an asset bubble or a recession, was a result of his many misguided interventions from 1987 till 2001. Of all these interventions, the LTCM affair was his biggest mistake.
- As Constantino Bresciani-Turroni notes in his book on the Weimar hyperinflation ‘The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany’, “even in the past times of economic regressions, of social dissolution, and of profound political disturbances have often been characterised by a concentration of property. In those periods the strong recovered their primitive habits as beasts of prey.” ↩
- For example, the last rate cut by the Fed came three days after TheGlobe.com set a record for the largest first-day gain of any IPO on Nov 13, 1998. ↩