Ages of American Capitalism (part 4)

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Now I turn to the last of Jonathan Levy’s four ages of capitalism, the “Age of Chaos” that began in 1980. Here is his overview:

What most distinguishes the Age of Chaos is a shift in what has always been capitalism’s core dynamic: the logic of investment, as it works through production, exchange, and consumption. Since 1980, a preference for liquidity over long-term commitment has dominated capital investment as never before. Fast-moving money, rapid investment and disinvestment, across various asset classes, as well as in and out of various companies, has not only overturned the old methods of production—its logic has often threatened to overwhelm other economic patterns. In short, the liquidity of capital has made for a chaotic age dominated by the vagaries of appreciating assets.

For Levy’s assumptions about liquidity, I refer the reader to my first post on his book, especially the section “Economic growth and the liquidity problem.” The gist of it is that the capitalist economy needs liquidity in some form, but too much of certain kinds of liquidity are a problem. Transactional liquidity—money to buy things—is essential, but too much speculative liquidity—money held for short-term trading—generates booms and busts in asset prices without increasing long-term investment, improving productivity, or generating sustainable prosperity.

This post discusses the two chapters that concern the 1980s and 1990s respectively, “Magic of the Market” and “The New Economy.”

The 1980s and the Reagan administration

Levy presents a balanced and insightful description of the interplay between Reaganomics and the economic developments of the 1980s. Reaganomics did not live up to either the hopes of its proponents or the fears of its detractors. Conservatives hoped that if the government would just get out of the way, the “magic of the market”—one of Reagan’s favorite phrases—would restore the postwar prosperity interrupted by the economic shocks and stagflation of the 1970s. But Reagan was unable to revive the manufacturing-based economy with its high productivity, broad-based income growth and trade surpluses. On the other hand, liberals feared that Reaganomics would undo New Deal accomplishments in regulation and income security, taking the country back to the bad old days of predatory robber barons and exploited workers. But many key elements of New Deal liberalism were here to stay, such as Social Security, securities regulation and progressive taxation. And Reagan himself wholeheartedly embraced one aspect of Big Government—higher spending on the military-industrial complex.

Arthur Laffer’s controversial “supply-side economics” had proposed that tax cuts, especially for the wealthy, would stimulate so much private investment and economic growth that they would pay for themselves by expanding the tax base. When that turned out not to be true, Reagan was forced to curb his tax cutting in order to deal with growing budget deficits. He did not succeed in ending the deficit spending that had become chronic in the “Age of Control.”

There was no going back to an earlier time, because a new kind of economy was emerging. Reaganomics didn’t create it, although it did influence it by favoring capital and weakening labor and government. But something else shaped it more decisively—the spike in interest rates engineered by the Federal Reserve under Jimmy Carter’s appointee, Paul Volcker, in order to tame inflation. It worked, but it also triggered the 1981-1982 recession and altered global investment patterns. As inflation fell and the economy recovered from recession, confidence in the value of the dollar returned. It was no longer based on the dollar’s fixed value in gold, however, but on the high interest lenders could earn on dollar-denominated assets. International capital flowed toward the United States, creating a strange new kind of global dominance—a “far more novel U.S. global hegemony.” Postwar America had been a net exporter of goods and capital, like powerful countries before it. Now capital “ran uphill,” and the world’s richest country became a debtor nation. The strong dollar helped Americans buy foreign goods, while making it harder for foreign consumers to buy our goods. But foreigners were happy to take the dollars they accumulated by selling to Americans and lend them back to us by buying American bonds earning high rates of interest. Foreigners helped finance both the trade deficit and the government deficit. As capital flowed in this direction, the U.S. economy had a surplus of credit, while poorer countries had a shortage of credit, reflected in the Latin American debt crisis of 1982.

Earlier, Levy discussed the highly speculative capitalism of the 1920s, which set the stage for the crash of 1929 and the Great Depression of the 1930s. Underlying causes included the manufacturing boom already in progress, the confidence in the currency after the return to the gold standard after World War I, and the quest for high profit margins to compensate for the high cost of borrowing. Levy sees a similar pattern in the 1980s:

Confidence high, to hurdle over the high interest rate, investors resorted to debt to leverage up short-term speculative profits in stocks, bonds, and commercial real estate especially. Speculative investment was back, as the dynamic factor in economic life, joining hands with an insatiable American consumerism.

In one respect though, the 1980s were very different from the 1920s. While the 1920s expansion was associated with the boom in manufacturing investment, the 1980s expansion occurred despite the disinvestment in manufacturing and the lack of any new surge in fixed investment overall. “As profit making shifted toward short-term finance, tellingly the macroexpansion of the 1980s remains the only one on record in which there was a declining share of fixed investment in GDP.” What did occur was a wave of speculative trading and investment in existing companies. There were takeovers by “corporate raiders” and “leveraged buyouts” financed by high-interest “junk bonds.” There were acquisitions of savings and loans by shady owners who took them into bankruptcy at public expense. And if the Ford Motor Company was the iconic firm of the early twentieth century, Donald Trump’s real estate company was a poster child for 1980s speculation:

Trump, leveraging his real estate assets and no less his celebrity, built his Manhattan real estate and Atlantic City casino empire on debt, funded by a “sprawling network of seventy-two banks”…. Trump was emblematic of a larger trend. He was a business concern with very little underlying income generation, relative to his assets, which he purchased through bank debt. When his assets increased in price, he used them as collateral for more loans, which became his income, given that his actual businesses usually lost money in the end. “Truthful hyperbole” was what Trump branded the business model in his ghostwritten autobiography The Art of the Deal (1987).

Reagan’s “capital-friendly policies,” especially tax cuts for the wealthy, contributed to the expansion, but maybe not as he intended. Much of the newly available capital went into speculation rather than productive investment. Some forms of deregulation, such as more permissive rules governing savings and loans and relaxed enforcement of antitrust laws, gave speculators more freedom to operate.

Sources of income also shifted in the 1980s, as income growth became less dependent on productivity gains and more dependent on asset appreciation. The people who gained the most were those who owned tangible assets like homes or financial assets like stocks and bonds. “The financial appreciation of the asset—through its sale (capital gains) or its capacity to be leveraged in credit markets—generated the pecuniary income.” After-tax income for the wealthy increased even more, because of tax cuts. Meanwhile, average hourly compensation for workers remained flat, but their households could increase their spending by taking on more debt.

The expansion that began after the 1981-1982 recession lasted until 1990. When the Federal Reserve raised interest rates in the late 1980s, fearing inflation, firms and households became more reluctant to borrow. Consumer spending declined, real estate values dropped, and the market for junk bonds collapsed. Donald Trump went bankrupt, although he would not stay down for long.

The 1990s and the Clinton administration

The collapse of the Soviet Union in 1991 was a “remarkably optimistic moment” for capitalism. There was even talk of the “end of history,” since capitalist democracy seemed to have emerged victorious over its greatest economic and political rival. Americans expected the United States to remain the strongest economy in the world, dominating what was becoming an increasingly global economy. Prosperity would depend more than ever on the free movement of capital, people and goods across national boundaries. All three, however, tended to flow toward the U.S., as the country continued becoming more a consumer of manufactured goods than a producer, and more a borrower of capital than a lender. The largest American company, Walmart, was not a producer, but a retailer, mostly selling goods made elsewhere.

The good news about the 1990s was that the total rate of fixed investment increased in spite of the continued disinvestment in old manufacturing industries. This was mainly due to new investments in information technology. Productivity growth accelerated and wages improved a bit, while inflation remained under control. The silicon microprocessor was a general-purpose technology adaptable to a wide variety of uses. Silicon Valley emerged as the leading center of the electronic revolution.

A silicon chip is a physical thing, much smaller but just as tangible as an industrial machine. Recall, however, Levy’s broader definition of capital—the “process through which a legal asset is invested with pecuniary value, in light of its capacity to yield a future pecuniary profit.” In the information age, intangible assets like data, social networks and technical skills meet that definition. Intellectual, social and human capital became more vital wealth-producing assets. Society became fascinated by the Internet as the “information highway,” the infrastructure for the free flow of ideas. In that respect, although the forms of capital were different, the emerging economy had something in common with the early manufacturing economy.

Back then, at the dawning auto-industrial society, financial activity sponsored new long-term fixed investments, just as the 1990s saw new long-term investments at the dawning of an Internet-based economy. (By contrast, the 1980s had been a moment of speculative disinvestment, with little creation.)

As promising as the “New Economy” was, it was emerging within a society with unresolved social issues, in particular the unfinished movements for racial, gender and economic equality. Some forms of human capital were highly valued, such as technical skills, while others were overlooked or devalued. Places in the vanguard of economic development, like Silicon Valley, had their divisions between hi-tech jobs for white men and lower-wage service jobs for women and minorities. Many other places didn’t have enough jobs of any kind, although they had increasing rates of incarceration.

President Clinton came into office in 1993 with a liberal agenda that included health care reform and pro-worker labor laws. But the following year, Republicans took control of Congress for the first time since 1954 and issued a very conservative manifesto, the “Contract with America.” Clinton couldn’t pass liberal legislation, but what he could do was embrace the wealth-creating potential of the “New Economy”:

During the 1990s, by contrast with the more improvisational Reagan administration, the “New Democrats” of President Bill Clinton articulated a coherent political-economic settlement for the new age. Clinton went all in on a finance- and technology-driven, center-left vision of “globalization.”

Clinton accepted the conservative proposition, “The era of Big Government is over,” and counted on the free flow of capital and trade to create prosperity for all. He approved the North American Free Trade Agreement (NAFTA) in 1994, and deregulation of telecommunications and banking in 1996. (The Glass-Steagall Act of 1933, which kept the same firm from engaging in both banking and investing, was repealed, mainly for the benefit of Citigroup.) Clinton also promoted the welfare reform bill that made public assistance more temporary and attached work requirements to aid for single parents.

President Clinton’s fiscal policy was also conservative, accepting the need for fiscal austerity and balanced budgets. The theory was that reduced government borrowing would “free up capital for long-term fixed investment.” In 1993, before Republicans took control of Congress, Democrats passed a deficit reduction measure that included both spending cuts and tax increases. As a result, by the late 1990s, the federal budget was in surplus for the first time since 1960. (Every Republican opposed Clinton’s deficit reduction plan, claiming that the budget could be balanced with spending cuts alone. But no Republican administration since Eisenhower has ever achieved that.)

Clouds on the horizon

The period from 1992 to 2000 was an unusually long period of sustained economic expansion. It was based on high confidence, often justified by long-term investments in emerging technologies and resulting productivity gains. However, assets like company stocks appreciated even faster than productivity and profits. In 1996, Fed chair Alan Greenspan warned that the stock market was beginning to show signs of “irrational exuberance.” Capital continued to flow into the U.S., and the quest of capital for high returns fed another speculative boom. As the federal government reduced its borrowing, more capital flowed into corporate stocks and bonds and less into Treasury bonds.

Although the Internet had great business potential, how it would actually fulfill that potential was not yet clear. In 1995, Netscape’s initial public offering sold for $3 billion, although it had no operating profits. So began the so-called “dot-com” boom, in which investors rushed to finance enterprises whose future returns were questionable, to say the least. “Capital had never before moved so quickly into a new asset class.” When E*Trade went online In 1996, stock-trading joined pornography and social networking as popular Internet pastimes. The Nasdaq exchange, which listed many of the Internet companies, reached a price-earnings ratio of 175, compared to a typical ratio of 10 to 20. Then it lost half of its value in 2000 when the speculative bubble burst. But that was nothing compared to the boom-and-bust cycle that would appear early in the new millennium.


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