Another Look at Why the Return to Capital is Low

(summary of presentation  based on my book, Political Economy of Tomorrow, delivered to Bank Credit Analyst conference yesterday)

Alice laughed.   There is no use trying; she said, “one can’t believe impossible things.” I dare say you haven’t had much practice, said the queen.  When I was younger, I always did it for half an hour a day.  Why sometimes I’ve believed as many as six impossible things before breakfast.    --Lewis Carroll, Beyond the Looking Glass

I offer to give you practice.  I ask that you contemplate and take seriously an impossible thing: That capital is not magical.  It is subject to the same laws of supply and demand and pressure to rationalize as any other commodity.   The reason the return of capital is low is that there is simply too much of it.  As novel as an idea that may sound, I assure you I did not make it up.  Rather, I suggest to you there is a subtext to the financial and economic history to which you are well acquainted that once understood this, the success of capitalism, to be its own major challenge.    

Also, rest assured this is not a rehashing of former Treasury Secretary Summer’s attempt to resurrect the secular stagnation hypothesis.  Summers thinks he just recently discovered the fact that the pool of saving exceeds the demand required for modern business.  His go-to-solution is a large-scale public investment project.  

The American economist, Harold Vatter, argued more than forty years ago that since the 1920s, net new investment was in decline.  The net, Vatter was discussing, was investment excluding depreciation.   The kind of technological progress that we experienced was not only labor-saving but capital saving as well.   Not as much capital was needed in the production of goods and services as had been the case.   What Summers sees as a special case, Vatter had identified it as a general case under modern capitalism.  

Surplus capital is the key political-economic challenge was recognized by American intellectuals and policymakers at the start of the 20th century.   They saw domestic outlets for the congestion and envisioned a consumer-oriented society and culture, creating new needs and desires, as well as a substantial social safety net—anticipating both Keynes and the New Deal.

They understood this was not sufficient, and looked for foreign outlets as well.  This was not simply an expansion of the rentier class of portfolio investors, content to clip coupons.  Rather what was envisioned was direct investment, building infrastructure in other parts of the world and developing a market for US goods and services.  This is a vision of a non-imperialist expansion.

The imperialist powers of the 19th century carved the world into spheres of influence.  A rising power of the time, the US, did not accept the inherited world order.  In the Open Door Notes, the US argued for a new global architecture that replaced the fixed spheres of interest with variable shares.  The variability would depend on one’s economic prowess.  The fixed spheres were products of rent-seeking behavior, currying favor with a political ruler to get economic concessions.  The new irreverend power’s variable share rewarded profit-seeking behavior. 

Besides the unfathomable loss of lives, World War I and II destroyed the surplus of capital.  Anticipating a return to pre-war economic conditions, the Open Door Notes were globalized in the form of the World Bank, International Monetary Fund and GATT (the predecessor of the World Trade Organization).  However, as the surplus capital rebuilt, strains on the system were evident nearly a decade before the eventual collapse of Bretton Woods, 46 years ago last month. 

The surplus savings was penned up by regulations and capital controls.  The offshore dollar market had already begun when the Soviet Union took their deposits out of US banks and brought that to British merchant banks.  Capital waged a two-front battle.  It enlisted the state to weaken organized labor.  Through regulatory capture, it freed itself from regulatory shackles. 

What we associate with Reagan and Thatcher was in effect turning the 20th-century Open Door strategy on its head.  The surplus capital problem was on a global scale, and the by exporting capital, the US only exacerbated the challenge.  Instead, Reagan-Thatcher was a new strategy to deal with the surplus.  The US, and to a less extent, the UK, Canada, and Australia, would absorb the world’s surplus savings and production.   This is to say the US (and a few other smaller countries) would run substantial current account deficits and capital account surpluses.

The Great Financial Crisis marks the end of the Reagan-Thatcher strategy to deal with the surplus capital, the formidable challenge to capitalism that has been lost by in the changing political narrative and an approach to economics which is infatuated with esoteric mathematical proofs.   When the conservative US President Nixon severed the last link between the dollar and gold and instituted wage and price controls, little did we have an inkling of the world Reagan and Thatcher were going to usher in a decade later.  

Similarly, a new strategy to deal with the surplus capital, is not within our grasp.  In the meantime, officials are trying to come up with other ways to absorb the surplus, including changes in the regulatory environment.   In some ways, it might be helpful to think about QE itself as an attempt to deal with the surplus capital.  

When farmers have a bountiful crop, and the price threatens to fall below the cost of production, governments often invent schemes to buy the crop and warehouse it and let the agricultural produce come to market at a better (i.e., lucrative) time.  In some ways, QE can be understood as a similar strategy:  Warehouse the surplus capital.  This is not a permanent solution.  There is a political push back on the grounds that it blurs monetary and fiscal policy.  There is an ideological resistance to the “interference” with market forces.  There are economic arguments against the distortion of prices and the mutation of printing signals. 

Interest rates are low, not simply because central banks are buying bonds and maintaining large balance sheets by recycling maturing issues.  Interest rates are low because there is too much capital.  It is a recurring source of the crisis in market economies.  We should anticipate that returns to capital will remain low until a new strategy to deal with the surplus is devised and accepted, and the risk is that we are still in denial. 

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