Is Capitalism In Peril Print E-mail



Is Capitalism In Peril? 

 We take pictures to commemorate, to validate and to remember. There are certain photos that we snap to share with others, some we save in an album or a box and a rare few that we frame and display. The ones we put on a mantle or desk often represent a meaningful chapter of our lives in snapshot form. As time flows by the reason we keep a picture on display may change as we do. We look back through the window of time with a different perspective and gauge the importance of the moment captured on film through wiser eyes. There are moments and photos whose significance may be misread in the blurring activity of youth and go unappreciated until life’s lessons fall into alignment, sharpen our focus and reveal a new story.

There is a picture on my desk of a bearded young man splitting massive blocks of pine with steel wedges and a sledge hammer maul. The light is fading with the afternoon sun deep in an Idaho forest. A diminutive creek rolls by the worksite. The creek is populated with brook trout no bigger than your hand and smarter than most who try to hook them.  In this snapshot a sledge hammer maul gripped by calloused hands is suspended above the man’s head while his body coils to deliver a firm and accurate blow destined to cleave the round block of pine into halves and then quarters. At the end of the day the blocks are split and loaded neatly onto the bed of an old Ford pickup for sale to customers in the valley below.

The picture was taken and a brief narrative written to share the allure of the western mountains with family back east and to assure a worried mother that her son was indeed still healthy and relatively well fed.

With money salted away from a meager teacher’s salary the young man purchased a truck, two chain saws and the assorted tools of the lumber jack trade. A firewood business was born. He learned the lessons of the forest and the mountains and how to drop a towering Pine into a narrow open space. More importantly he learned the value of market research, pricing, advertising, supply and demand, managing expenses in a seasonal business and protecting trade secrets. The young man learned the lessons of basic capitalist economics. Without realizing it a fly-fishing backcountry ski bum seeking freedom more than cash became infected by the powerful lure of the entrepreneurial spirit.

I look at that picture today and marvel at the serene beauty and think back to the simplicity of a young man’s life. But the picture has new meaning for me now. A man turning dead trees into a profitable revenue stream represents capitalism in its purest form. Hard work, smart marketing, efficient execution of a business plan and the delivery of a tangible product on time and under budget comprised a recipe for success in 1982. This form of capitalism is simple, elegant, repeatable, scalable and sustainable.

Today’s global economy predicated on complex credit structures and debt financed production and consumption is another story. Technology, speculation, imprudent education standards, misguided tax policy, third world labor arbitrage and ironically, increasing productivity have contributed to the stagnant wages of many, unemployment for millions and unfathomable wealth for a very few. This iteration of the capitalist dream is faltering badly. Perhaps it is time we recognize that genius lies not in complexity but in simplicity and that finance is a conduit for efficient capital distribution that feeds industrial activity and that finance is not itself industry. When finance funnels capital to itself it starves productive commerce to the detriment of society.


Global Capitalism

The world’s economy is suffering from a rolling financial crisis that has its roots in property speculation, complex credit structures, and excessive banking leverage and consumer debt. The genius of Minsky foretold the credit crisis. Keynes provided a theoretical solution to the crisis. The Keynesian solution has stalled global collapse at the cost of unsustainable public debt.

We witness a comedy of disastrous proportions in Europe that currently features the European Central Bank providing three years of unlimited guaranteed credit to ailing banks in hopes that the funds will be spent supporting the debt issued by struggling sovereigns including Greece, Portugal, Spain and Italy. Regulators now demand greater capital reserves at the banks to offset the default risk of the sovereign debt held in bank portfolios. I envision a circle of chimps, each armed with a stick provided by a ratings agency, hitting his neighbor to the right in a never ending cycle of painful waste.

Sadly the Euro Zone problems have escalated and spread from those of weak peripheral countries like Greece and Ireland to a catastrophic crisis of confidence about the solvency of some of the world’s largest governments. The ratings agencies have engaged in credit downgrades of the sovereign debt of Spain, Italy and even France. The future of the Euro Zone as a viable monetary union and the survival of the single currency are uncertain. Euro Zone Banks are loaded with questionable debt, some private and some public. Lack of confidence in financial institutions limits their ability to raise much needed regulatory capital in free markets. A credit crunch appears imminent as does at least a mild recession in Europe.

The International Monetary Fund

Rising borrowing costs will make repairing public budgets in struggling countries more difficult as will ironically, further austerity measures. Rising rates also make fiscal stimulation of flagging economies prohibitively expensive and politically unpalatable. The IMF has called for greater collective contributions from the world’s largest economies to increase the Funds ability to respond to ailing economies. The Fund seeks $1 Trillion to aid the most pronounced failures of the finance based version of capitalism. The IMF is also calling for The European Financial Stability Fund to double in size, claiming it is inadequate to address any new major debt emergency. The IMF also asks that the European Central Bank (ECB) continue its Quantitative Easing, buying the sovereign debt of troubled governments.

As I write Greece is in negotiations with private creditors to avoid default. The fear of the IMF and others is that a sufficient firewall between Greece and the remaining 16 nations of the Euro Zone does not exist to prevent a credit contagion from spreading thus increasing the likelihood of a deeper recession with global implications. But even in this dire situation fraught with global ramifications a perilous game of “who blinks first” continues. As Greece slides toward default its creditors want to be certain that the last drop of blood has been squeezed from the stone, Germany resists bulking up the European Financial Stability Fund, beyond current commitments, the ECB does not want the role of lender of last resort and the US wants the Euro Zone to do more to solve its problems before committing more dough.

IMF chief Christine Lagarde voiced a dire warning urging Euro-Zone leaders to enhance the European Debt Crisis firewall, implement pro-growth policies and further integrate the monetary union or face a potential depression-era collapse in the global economy.

The IMF expressed concern for emerging markets including China, citing real estate and credit markets as potential catalysts for deep financial disruption. And finally the Fund predicts sluggish growth for the US, Japan and the UK. Something around 1.5% is their call, barely enough to maintain current employment levels and spotty consumer demand.

Few voiced concerns of moral hazard when the global economy was humming along. Today, particularly in Germany, leaders pronounce trepidation regarding a bailout of the Mediterranean nations. Prevention should always be preferable to bailouts. It is too late to reverse the bank rescues, the ultimate in moral hazard, but we should not be surprised that citizens of weakened nations suffering from declining standards of living resist further belt tightening.

Such a mess has man made of things with his focus on intangible wealth production and hollow economic growth that substitutes debt for income and moral hazard for market discipline. Quantitative Easing (QE) abounds in Europe, Japan and of course right here in the good old USA. It is precisely QE that removes capitalist free market order from sovereign debt issuance. When central banks and governments collaborate to print money to buy public debt, price/yield discovery is aborted and we have no idea what the true cost of Italian or American 10 year government borrowing actually is. Reciprocally we can only guess at the sustainability of the recovery such tactics buys.  

The US Struggle for Recovery

The beauty of macro-capitalism lies in its potential to create and sustain a broad, healthy, educated and ambitious middle class. The simplicity of what we egocentrically call the “American Dream” is illustrated in the story of the young man armed with a chain saw, a pickup and the determination to enjoy the lifestyle of his choosing. It is an idea so powerful that nations rally to the call of the individual freedom to succeed or fail based upon brains, brawn and a fair shake.

 And yet here in America, home of Capitalism’s greatest success stories we find widespread discontent. Recent polls here and in England disclose a disturbing trend. In 2011 the Edelman Trust Barometer told us that less than half those polled believed business could be trusted to do the right thing- only slightly ahead of Russia. There is increasing talk of a “crisis of legitimacy” in capitalism. Widening inequality, summed up in the opinion of the Organization for Economic Co-operation and Development- the world’s richest nations- declared that the wealthiest Americans have “collected the bulk of the past three decades income gains”. The top earners include corporate executives and financiers. In his 2011 book, “The Cost of Inequality”, Stewart Lansley writes that the modern economy consists of two tracks, a fast one for the super rich and a stalled one for everyone else. Those trapped in the slow lane had enjoyed a modestly improving standard of living despite stagnant income as they liquidated frothy equity value from their homes. The collapse of housing prices has ended the fantasy of mutual benefit for rich and poor alike. Lansley states that finance has become “the cash cow for the global super-rich elite”. 

Americans are raiding their savings, retirement accounts and cutting back on college savings to make ends meet. Our savings rate has dropped back to the lowest levels since December 2007. Chicago Federal Reserve President Charles Evens says “Americans have been spending recently in a way that did not seem in line with income growth.” Charlie goes on to say,” If they saw future income and employment increasing strongly that would be reasonable. But I don’t see that.” Just as we raided the equity in our homes before the crash now Americans are taking from retirement savings. Aon Hewitt’s survey of 150,000 401(k) owners shows almost 1/3 has a loan outstanding, up 20% last year across all demographics. Among lower wage earners the figure reaches 60%. “Apparent stronger consumption at year end was associated with falling savings rates, compensating for stagnating income growth” according to Dennis Lockhart, president of the Federal Reserve Bank of Atlanta. Clearly, consumption cannot be sustainably increased without a corresponding uptick in income.

At a time when America’s competitive future relies on quality higher education money is flowing out of 529 plans, tax advantaged funds designed to help families meet the rising cost of college. Outflows were $354 million between July and September, 2011 contrasted with nearly $1 billion inflows for the same period in 2010. Household borrowing for all types of revolving credit took the biggest jump (10%) in over a decade between October and November, 2011. Americans borrow twice for college what we did a decade ago and now carry more college than credit card debt.

America is raiding its savings and ravaging personal balance sheets trying to hold on until a meaningful recovery takes hold. Many are in a race against time to preserve their piece of the “American Dream” and preserve a faltering standard of living.



Define Recovery Please…

I have often heard it said that “A rising tide lifts all boats”. This metaphor is often brushed off when a policy solution to an economic problem appears to favor one constituency vs. another. Would then not the reverse be true; meaning that “an ebbing tide lowers all boats”?  Pragmatists are born when they accept the fact that life isn’t fair. To be clear, it is a darn good thing that recessions and depressions don’t choke off all private enterprises or the seeds of recovery would be scant and society trapped in deep mud. Americans have come to accept that for the greater good an occasional ne’er-do-well may benefit. But in a competitive market economy this injustice must be kept to a minimum or the public’s faith in capitalism is damaged.

Keynes is quoted as saying,” The businessman is only tolerable so long as his gains can be held to bear some relation to what roughly and in some sense, his activities have contributed to society.”  And for those who say that capitalism is a high stakes blood sport where “winner takes all” conditions demand and deserve great reward for the victors one might respond that privileged and protected losers are making off with some serious money these days. Top executives rewards display little positive correlation to performance and mostly rise in the face of falling profits or faltering bank balance sheets. And regarding “too big to fail” one must consider the words of Otmar Issing, former member of the ECB’s executive board,” The rules of the game should be clear. Those who succeed are free to take the profits (after taxation); those who make losses have to bear the consequences, with bankruptcy the ultimate sanction. Thus “too big to fail” not only undermines a fundamental principal of market economies but also a principal of societies in which individuals are responsible for their actions.”

This is the era of the Techno-Global Revolution. For the fortunate few there has been only a hint of the recession now viewed in the rear view mirror. For many the consequences of capitalisms recent mishaps have been and currently range from disconcerting to devastating.

Remembering the Jetsons

Capitalism is a system based on a set of beliefs that are general enough to provide a variety of interpretations. In many ways the version of capitalism practiced varies from country to country and is a reflection of the underlying culture of the participants. This is the greatest barrier to any long term success the EU is hoping for. Could the Greeks and Germans be any more different in the eyes of Adam Smith?

 In the US we have short attention spans and timelines. We look at quarterly results and operate on the premise of “what have you cost me lately?” That approach imperils the execution of planning and making business decisions that will stand the test of time often to the detriment of social continuity. This American brand of capitalism drew these comments from John Plender in the Financial Times series entitled Capitalism in Crisis, “What is unquestionably novel is the ferocity with which US business sheds labor now that executive pay and incentive schemes are more closely linked to short term performance targets. The American worker has gone from being regarded as human capital to a mere cost.” Few things can contribute more to divisions within a culture than pitting one segment against another in regard to financial interests. 

Ah, Saturday morning, a bowl of Trix cereal and cartoons! The Jetsons cartoon was a staple for many of us born in the ‘50s. George, a computer engineer, his wife Jane, kids Judy and Elroy lived in the futuristic utopia of 2062. George and family enjoyed a laid-back existence complete with work saving devices and robots. George worked a blistering 9 hours per week for Spacely Sprockets (full time) battling against arch enemy, Cogswell Cogs. In this fantasy the Techno-Global Revolution produced a comfortable life for all. But in today’s world we witness a restructuring of capitalism’s workload. In 1900 41% of Americans worked the land; today less than 2% are farmers thanks to technology and machines. That labor force was largely redeployed to manufacturing and saw an improvement in their standard of living. There is nothing new about the battle between man and machine. But consider the social implications of University of California’s James Hamilton findings that “In 2005 the average worker could produce what would have required two in 1970, four in 1940 and six in 1910.” Okun’s Law teaches econ students that for every three percent gain in output unemployment should decline by one percent. Today’s unemployment rate should be near one percent rather than nine percent considering the improvements in productivity. Perhaps it is time to scrape Okun “law” from the textbooks and encourage new thinking.

It is clear that the wealth gained through technological advancement is bypassing obsolete labor and being held by executives and shareholders. The fastest job growth is among high and low skilled workers with the middle class facing extreme pressure. Technology is dividing labor into winners and losers and our brand of capitalism is being practiced in a way that divides society into those that have and those that have less than they used to. Each job represents a consumer; each dollar earned circulates through the economy as demand. Consumption represents 2/3s of the US economy. The implications for a “recovery” in jobs, housing and tax revenue and social expenditures seem clear. Solutions will take time and a refocus of energy and resources if we are to avoid a lost generation of Americans left behind by the Techno-Global revolution.

Time to Re-evaluate the Role of Education

It’s hard to find an American outside the NEA that doesn’t see room for improvement in our public education system. As a former educator I am obliged to pile on.

By some estimates there are between two and three million jobs going unfilled in America do to a lack of properly skilled workers. It is understandable that the Techno-Global Revolution took so many by surprise for that is the nature of revolutions. It is time to refocus now that the new reality is so very clear. A cooperative effort between business and education must be undertaken to rejuvenate the floundering middle class performing the most basic of capitalist functions- matching supply with demand in search of optimal performance. Our public education system has fallen prey to the misguided allocation of capital and rewards to finance and away from tangible production. Man’s genius presents itself in art, science and math. Genius can be wasted when faulty incentive systems encourage the brightest mathematicians, engineers and physicists to build esoteric alternative investment structures rather than “things” more valuable to society. And the waste of misguided resources shows itself most clearly in the inevitable failure of so many financial innovations because they are designed by minds disciplined to perform in the physical world and are so regularly and completely undone by the emotion of man.

The Fed Has Played Its Hand

Early in the 20th century America and the world began practicing fractional reserve banking; making loans and investments in excess of actual tangible capital. In 1971 America led the world’s departure from the gold standard, removing the anchor that tethered currency to hard assets. Debt creation became limited only by the perception of a nation’s ability to cover its debts through revenue sustained by economic growth and responsible fiscal policy.

Dominant Central Bank philosophy includes the belief that lower interest rates spur aggregate demand, an idea that supported increasing debt fueled consumption and the theory of supply side economics. We now find our economy stagnant and weak, our government overextended and the billions upon billions in rescue money trapped in the largest central and commercial banks.

The Fed continues to push on this frayed string, buying bonds to flatten yields to a zero bound range well out the maturity curve. This act has damaged the economy in the short term by removing incentives to lend even when borrowing cost hover near 0%.  Retired consumers living on investment income are strapped with declining standards of living. The long term price is more difficult to decipher but is no less dangerous. For you finance pros out there the idea is simple, the present value of future liabilities rises as interest earnings decreases. Companies and people will need to save more and consume less, if they are able, to meet needs in the future. It is clear that we currently have the capacity to produce vast amounts of low cost credit beyond any viable demand. The Fed’s formula has lost its traction and effectiveness and yet we hear more talk of Quantitative Easing later this year and zero rated into 2014. This has clear implications for pensions, health care costs and ramps up the cost of unfunded liabilities of all kinds.

America’s problems run deep. Our issues include income and wealth distribution, anemic aggregate demand, housing and unemployment, political paralysis, a need for campaign finance reform, a misguided Fed and tax and education systems in serious need of overhaul.


Investment Outlook

Interest rates on government bonds will be artificially depressed by monetary policy. As the Fed intends it to be, value will reside in risk assets. Short maturity high grade corporate securities, especially those with floating coupons offer value. Callable agency bonds offer spreads to Treasury securities. It is not a time to dabble in the latest new-fangled alternative investments or to take excessive credit or duration risk. Free market price/yield discovery will return when the fed steps out of the way or when the markets lose faith in current policies or leaders. That is when the cautious will be rewarded and wise fiduciaries will sleep better than most.

Life’s lessons are falling into alignment. We may have missed them in the hubbub of meteoric economic expansion and asset bubbles. It is time for America to roll up its sleeves, build a few calluses and strike a blow of the production of tangible things. Let’s realign our capital with our needs and our enormous capacity for techno-creativity with the future. Let’s have our brightest math and science wizards build the America of the future rather than the next meaningless derivative.

Happy Belated New Year To All!