Ages of American Capitalism (part 5)

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Continuing with the last of Jonathan Levy’s four ages, the “Age of Chaos,” I turn now to the present century and the period including the Great Recession of 2007-2009, the worst economic crisis since the Great Depression. Someday, Americans may look back and see it as the start of a new era in economy and government. So far, however, Levy observes mostly continuity since 2009, and not the new “democratic politics of capital” he would like to see. More on that later.

The “Great Moderation”

In 2004, Ben Bernanke, a governor of the Federal Reserve who would later become its Chair, used this term to describe the economic stability he believed had been achieved. (If this sounds familiar, I recently described Binyamin Appelbaum’s take on the “Great Moderation” in my third post about The Economists’ Hour.) At the time Bernanke was speaking, there had been only 16 months of recession in the previous 21 years. He credited this achievement especially to sound monetary policy, tight enough to control inflation but flexible enough to alleviate recessions by lowering interest rates as needed. Bernanke’s views expressed the capitalist confidence of the time—not only in the stability of the currency, but in the continued growth of economic demand and corporate profits.

Profits were growing rapidly in the 2000s; the bad news was that few of the economic benefits were reaching the average worker. Labor’s share of the national income was plummeting. Levy attributes that to another “credit-fueled and asset-priced” expansion, “which distributed, logically enough, more money to the property owners of assets, rather than to working people.”

Levy then provides a global perspective on this uneven expansion. Much of the world was experiencing an economic boom, but with some noteworthy imbalances. Manufacturing was booming in developing countries with historically low wages, led by China. Other developing economies prospered by meeting the increasing global demand for commodities like oil or iron. Countries of the new European monetary union were expanding their global financial services. The United States contributed a boom in housing and consumption heavily fueled by debt.

The relationship between the U.S. and China was pivotal. China’s communist leaders chose to save and invest much of the revenue from manufacturing exports. While holding down wages and consumption at home, they invested heavily in the United States, in effect financing the soaring U.S. trade deficit. (The federal budget also went from surplus to deficit as the George W. Bush administration cut taxes but increased military spending after 9/11)

The Federal Reserve had lowered interest rates as the economy slowed in 2000-2001. Now the combination of lower-cost loans in the U.S. and capital reinvested by the Chinese produced a “liquidity glut.” That fueled a speculative bubble in U.S. assets, especially housing. The moderation described by Bernanke gave way to a period of speculation and volatility, leading in a few years to financial breakdown.

Sources of profit

Levy does not claim that the American economy of the new millennium was based on speculation alone. Real businesses produced real goods and services and earned real revenue. Internet companies—so many of which had failed in the dot-com bust of 2000—were finding ways to become profitable. One way was to collect massive amounts of user data and sell it to marketers, as Google and Facebook did. Another was to gain a huge advantage over the competition by developing an especially powerful marketing platform, as Amazon did. Levy notes that such business concentrations challenge the thinking of the Law and Economics movement, which had weakened antitrust enforcement on “the assumption that short-term, rational profit maximization among firms would always increase competition to the benefit of all consumers.” One reason why labor’s share of national income declined was that big companies in highly consolidated industries had more power to set wages.

The benefits of the new economy were distributed unevenly, not only because of the growing power imbalance between business and labor, but because of the increasing premium placed on education and skills. The wage gap between college-educated and non-college-educated workers widened. Geographical disparities were also evident, as centers of technological innovation like Silicon Valley flourished, while old manufacturing cities and many rural areas declined. Unemployment remained stubbornly high in what was called a “jobless recovery,” since high-tech industries didn’t employ enough people to compensate for the decline in manufacturing employment. What job growth did occur was more in low-wage services.

A serious underlying problem was that the growth in profits was outrunning the growth in investment and productivity. Levy says that “productivity growth in general disappointed because few potentially productivity-enhancing innovations appeared.” Economic rewards flowed to the owners of intellectual capital (“Big Data”) and human capital (education), but not to enough workers. The investments that might have enhanced the productivity of ordinary workers were not, for the most part, forthcoming. But consumption could still grow if those with stagnant wages could compensate by assuming more debt. That’s where the liquidity glut came in, making it easier to extend debt to people at many income levels. That’s how the expansion of the 2000s turned into the great housing boom of 2003-2006.

U.S. housing prices shot up. Through a “wealth effect,” capital gains on leveraged property ownership could translate into new incomes for American homeowners. The housing stock thus became a new personal income flow. The age’s capitalism of asset price appreciation had found a new asset class to concentrate on, as many ordinary homeowners were given the chance to participate in the game of credit-fueled asset price appreciation. As in credit cycles before, it only worked so long as confidence was maintained, and prices kept going up. That was what the Great Moderation had come to depend on.

In booming cities, residential construction and home prices surged because of increased demand and short supply. But they could flourish in more depressed areas too because of riskier subprime mortgage loans (often with initially low but potentially very high rates). President Bush boasted about the “ownership society,” where ownership of a wealth-producing asset was open to all. The financial services industry constructed a $4 trillion pyramid of mortgage-backed securities on shaky ground. The securities became farther and farther removed from the real financial state of the borrowers and the affordability of the loans. Big banks created various classes of mortgage-backed securities, combined them in complicated ways until rating agencies underestimated their true risk, and even had them backed by insurance companies that also misjudged them.

Levy regards the economic expansion of the 2000s as a “wasted opportunity to make broad-based investments in economic life.” Too many dollars flowed into speculative real estate investments, based on the assumption that home prices would continue rising and workers with stagnant wages could make the payments on their subprime, adjustable mortgages. Meanwhile, “the alarm kept sounding that man-made climate change required long-term fixed investments in a new energy system to capture and reduce carbon emissions.” And climate change was not the only pressing national need being neglected.

The Great Recession

I have discussed the 2008 financial crisis and the associated recession many times, most recently in my summary of The Economists’ Hour, part 3. Levy’s interpretation is based on his understanding of the dynamics of capitalism, including the long-term, linear trend of technological advance and the shorter-term cycles of confidence and credit. The crash of 2008 marked the end of a particularly speculative credit cycle, when a liquidity glut suddenly gave way to a liquidity shortage.

The expansion of the 2000s came to depend heavily on the housing boom, which depended in turn on the extension of credit to home buyers whose low incomes limited their ability to repay the kinds of subprime, adjustable-rate mortgages they were getting. The risks were disguised by complex and overrated securities based on those mortgages. As long as buyers kept buying and confidence in rising home values remained high, the boom could continue. When housing prices peaked in 2006 and loan defaults increased, the bubble burst. Mortgage-backed securities suddenly lost value, and investment banks whose balance sheets were loaded with them could no longer raise cash either by selling them or borrowing against them. The collapse of Lehman Brothers in September 2008 triggered a massive contraction of credit.

Nervous, precautionary hoarding among the global owners of capital broke out on a massive scale. Capitalism regressed back to where it was during the Great Depression of the 1930s—mired in a liquidity trap. Across the board, spending of all kinds, whether for investment or for consumption, dropped off. Employment collapsed.

The “ownership society” celebrated by President Bush, in which Americans would prosper together by owning rapidly appreciating assets, had failed. “Due to collapsed housing prices, between 2007 and 2010 median wealth declined 44 percent—back, adjusted for inflation, to where it had been in 1969.” (That large a drop may sound hard to believe, but a family with a $300,000 home and a $250,000 mortgage has only $50,000 in equity, which drops by 44% if the house loses just $22,000 in market value. Many families have little net worth outside of their home.)

What was different in this financial panic was that the federal government quickly intervened to restore liquidity. The standard procedure of cutting interest rates to ease borrowing and expand the money supply was not enough. In addition, the Federal Reserve arranged and subsidized the buyout of investment bank Bear Stearns by JP Morgan. It made a large loan to AIG, the largest insurer of mortgage-backed securities. The Troubled Asset Relief Program (TARP) authorized the Treasury to buy “toxic assets” that companies could not otherwise sell. (Actually, Treasury injected the cash mainly by purchasing non-voting stock in the companies.) In 2009, the new Obama administration got Congress to pass the American Recovery and Reinvestment Act, which stimulated the economy with tax cuts, aid to states, infrastructure projects and government research programs. In 2010. the Federal Reserve adopted its policy of “quantitative easing,” buying up long-term Treasury and mortgage bonds in order to bring down long-term interest rates. (The higher the demand of lenders for bonds, the easier it is for borrowers to borrow at low rates.)

Although these measures alleviated the immediate crisis, economic recovery was slow. Little was done to prevent ten million homeowners from losing their homes to foreclosure. Nevertheless, a new conservative movement, the Tea Party, formed around the complaint that the Obama administration was doing too much to help “freeloaders” and not enough for “hardworking Americans.” Rather than rallying around Obama as earlier generations of Americans had rallied around Roosevelt, a substantial segment of the electorate still wanted less government, not more.

The limits of reform

On the other hand, Barack Obama was no Franklin Roosevelt either. He filled his administration with leaders associated with the moderate Clinton administration—economic thinkers who had trouble thinking beyond the restoration of financial stability. The Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) tightened regulation on the big banks and securities ratings agencies. But unlike Roosevelt, Obama didn’t have the benefit of many years of more sweeping proposals—in FDR’s case from the Populist and Progressive movements—and a public that was willing to try them. Even Obama’s rather moderate proposal for subsidized health insurance stirred up ferocious opposition.

Levy regards the Obama years as another lost opportunity. Because government could borrow money at near-zero interest rates, it was a great time to consider bigger public initiatives:

[M]any productive opportunities for spending cried out: to repair public infrastructure on dilapidated roads and bridges, to lay the foundations of a “green” energy grid, to invest in productivity-enhancing technology, or to support early childhood education to reverse the drastic effects of education gaps in the future labor market, to name some obvious candidates.

After Levy wrote those words, Joe Biden proposed such an ambitious agenda. But what Levy observed in the aftermath of the Great Recession was a “Great Repetition,” another expansion led more by asset speculation than by productive investment. This time it was an expansion of corporate debt that led the way.

Levy observes that each transition from one age of capitalism to another has required some form of state action. The victory of the Republican Party in 1860 and the Civil War ushered in the Age of Capital, as the nation transitioned from an agrarian economy based on land and slaves to a manufacturing economy based on steam-driven machinery. Then in 1932, the New Deal ushered in the Age of Control, as government tried to guide the economy with regulation, income supports, and fiscal or monetary policies to counter extremes of the business cycle. The “Reagan Revolution” of 1980 reacted against the reliance on government in the Age of Control and initiated the Age of Chaos.

A new age of capitalism—which Levy does not name and does not yet exist—would require more than an income politics focusing on the distribution of the benefits from capitalism. It requires a “democratic politics of capital,” giving citizens a voice in directing capitalist investments toward socially useful ends. Traditionally, government has directed investment primarily to wage war and maintain a military-industrial complex. Otherwise it has left major investment decisions to the private sphere and the owners of capital, who waste too much capital on short-term speculation. Now other urgent national needs may call for an expanded conception of public investment. Levy would probably like Biden’s concept of “human infrastructure.”

Readers who are not put off by the length of this book will find it historically informative and intellectually challenging. I highly recommend it.

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