The following 2nd contribution to the debate summarizes in brief my perspective—neither Mainstream nor contemporary Marxist—on the causes and consequences of the crisis in general, and specifically how financial cycles and real cycles interact to create a crisis that is not a normal recession and not yet a bona fide depression—or what I have called an ‘Epic Recession’. The latter cannot be resolved, I argue, by traditional fiscal-monetary policies, and so long as it remains unresolved the potential increases for it transforming into a bona fide global depression. My perspective is presented in the form of 20 propositions, which I apologize for beforehand as, due to the requirements of debate, are necessarily too brief and general.
Deep capitalist cycle contractions (depressions and epic recessions) are driven by endogenous forces, both real and financial, that mutually determine each other, with different relative magnitudes and directions of causality that vary with the phase of the long run boom-bust cycle.
The key endogenous Independent variable is not profits but Investment—the latter comprised of two fundamental components: real asset investment (Ig) and financial asset investment (If).
Over the boom phase of the cycle, the composition and relative weight of total investment shifts from Ig to If. In the early boom phase, financial assets are created as a one-to-one representation of the market value of real assets. A mortgage is equivalent to the original market value of a new structure, for example. But as the boom phase of the cycle progresses, If expansion becomes increasingly independent of Ig—driven by excess money liquidity, proliferating forms of credit decoupled from money, increasingly leveraged debt financing, and the increasing demand driven character of financial asset price inflation over the boom phase of the cycle.
Money may serve as credit; but credit is not limited to the money form. Credit is simultaneously money and more than money. Money may function as ‘outside credit’, but credit is also created ‘inside’ and autonomous of money. Money and autonomous credit are key to understanding the relative shift from Ig to If over the boom phase of the cycle.
The relative and absolute shift from Ig to If over the boom phase of the cycle creates destabilizing asset price bubbles and financial crashes that in turn produce deeper and more durable contractions of the real economy than typically occurs in the case of ‘normal’ recessions that are not precipitated by, or associated with, financial instability events. Depressions and epic recessions are not normal recessions ‘writ large’, but reflect the outcome of unique qualitative forces associated with financial cycle volatility.
An explosion of both money credit and autonomous credit has been occurring since 1945—the process accelerating with the collapse of the Bretton Woods International Monetary System after 1973; with the global ending of international capital flow controls in the 1980s; with the digitization of financial transfers in the 1990s; and with the global expansion of shadow banking institutions, very high net worth professional investors, highly liquid secondary financial markets, and the proliferation of multiple new forms of financial asset instruments.
Decades of excessive liquidity and autonomous credit creation has resulted in a shift to greater debt and growing debt-leveraged financing, which accelerates If forms of investment more than Ig, and short term speculative financial forms of If in particular. Rising debt leveraged financing results in more frequent, larger, and more globalized asset price bubbles and corresponding financial instability.
There is no such thing as ‘the’ capitalist price system. There are several price systems. They do not behave alike. The system of financial asset prices is more volatile, in terms of both inflation and deflation, than product or factor (e.g. wage) input prices. Unlike the latter, financial asset prices are driven increasingly by speculative demand over the course of the boom phase of the cycle, and late boom phase in particular. Financial asset prices are subject to little or no supply force constraints during the boom phase, unlike product or factor prices. As financial asset inflation occurs, demand drives prices higher, invoking still more demand, until further price increases are unsustainable and the asset price bubble collapses. Asset price deflation following the financial bust in turn drives product and factor (wage) deflation. All three price systems mutually determine each other in a negatively reinforcing way during the initial stage of the bust phase of the cycle. Asset and product price deflation together dampen Ig, leading to employment declines, wage deflation, and falling household income and consumption. Business and household defaults follow, in turning provoking more asset, product, and factor price deflation that result in rising real debt levels. A generalized downward spiral of debt-deflation-default sets in, resulting in a deeper and more durable contraction of the real economy. The capitalist price mechanism thus plays a central role in destabilizing the system—both in the boom and bust phase—contrary to prevailing mainstream economic ideology that the price system works to restore equilibrium and stability.
The forces driving financial asset investment, If, slow real asset investment, Ig, during the late boom phase by diverting financing from Ig to If, and thereafter subsequently accelerating the already declining Ig during the initial bust phase. The growing frequency, magnitude, scope, and duration of financial investment, bubbles, and crashes over the long run thus have a combined negative impact on Ig—i. e. more slowly during the boom phase (a structural effect) and more rapidly during the bust phase (a cyclical effect). This long run decline of Ig relative to If due to both structural and cyclical causes convinces successful real asset investment companies to shift more toward If forms of investment. Thus, a company like General Electric, for example, perhaps the largest manufacturer in the world, increasingly shifts to and relies upon portfolio (e.g. financial asset) investing over the longer term.
This overall ‘Financial Shift Effect’ further results in non-financial capitalist enterprises seeking to reduce labor and other factor input costs over the longer term by various measures—i.e. reducing labor costs by moving to offshore markets, demanding further tax concessions and subsidies from the state, reducing inter-capitalist competition costs (free trade), shifting operating cost burden to workers and consumers (industry deregulation), and restructuring labor costs in the home market (de-unionization, more part time-temp labor, cutting social security-medicare and private pension ‘deferred’ wages, shifting medical costs to its workforce, reducing paid time off, delaying minimum wage adjustments, etc.), to name but the most obvious.
Income for the ‘bottom 80%’ primarily wage earning households progressively stagnates and declines over the boom phase of the cycle, as operating income for both financial and non-financial corporations in contrast rises. To offset declining real income for the 80%, consumer household credit and debt grow—especially mortgage, student loan, credit card, and installment loan forms. Terms and conditions of debt repayment are typically ‘lenient’ during the boom phase, thus serving to accelerate credit and debt accumulation. Financial institutions are more than willing to extend credit and debt to such households, charging interest that in effect represents a claim on future, not yet paid wages.
Systemic Fragility grows over the boom phase, accelerating in its later stages, composed initially of both business Financial Fragility and household Consumption Fragility. Fragility is a ratio and a function of three elements: rising indebtedness, declining liquid income, and the terms and conditions for which payment on incurred debt is made. Mainstream economics bifurcates this ratio: the Hybrid Keynesian wing considers income but largely disregards finance, credit and debt as equivalently important variables; the Retro Classicalist wing considers credit and debt but de-emphasizes the role of income. Both minimize the importance of ‘terms and conditions’ of repayment by focusing only on a subset—the interest rate—of this third element determining fragility.
Over the boom phase, rising household indebtedness amidst stagnating and declining household income represents rising ‘Consumption Fragility’ (CF) within the system. Similarly over the boom phase, rising financial institution (banks, shadow banks, and portfolio operations of large corporations) indebtedness that occurs with the increasing shift to debt-leveraging financing of If, represents ‘Financial Fragility’ (FF). Financial fragility during the boom phase is obscured by rising financial asset inflation. Consumption fragility is obscured by the continuing growth of consumption driven by debt. Both obscured effects disappear with the onset of the boom phase, revealing the true condition of fragility deterioration during the boom.
During the boom phase, a third form of fragility—Government Balance Sheet Fragility (GBSF)—also grows, as successive financial instability events of growing intensity require repeated government bailouts of financial institutions and as fiscal stimulus policies are introduced in successive (normal) recessions to assist recovery of non-financial corporations. In addition to these cyclical contributions to GBSF, structural causes also contribute to GBSF, as legislated tax cuts and subsidies for corporations adds further to government debt and thus GBSF. Thirdly, in the particular case of the United States, the policy choice since the 1980s to run annual and growing trade deficits adds still further to total deficits and debt levels. Dollars accumulate abroad due to the trade deficits and US trading partners agree to recycle the dollars back to the US by purchasing US Treasury bonds. Knowing the bond purchases will continue, the US federal government cuts taxes and increases spending further still, thus raising the deficit and total government debt. Federal debt consequently grows from less than $1 trillion to more than $15 trillion in the process. GBSF rises due to rising debt and falling (tax revenue) income.
During the initial bust phase following a financial crash, financial asset prices collapse and financial fragility accelerates, with its consequent effects on real Ig, employment declines, and the debt-deflation-default processes previously noted. Simultaneously, Consumption Fragility—already rising during the boom phase—deteriorates even more rapidly, driven by income declines due to mass layoffs, wage-benefit reductions, shorter hours of work and weekly earnings, and negative wealth effects as savings levels and rates of growth collapse. The financial crash thus precipitates a further ‘fracturing’ of both financial and consumption fragility. By means of the price system and the debt-deflation-default process, Financial and Consumption Fragility thus exacerbate each other in the course of the downturn. Just as the financial side of the economy causes a deterioration of real side conditions, the latter in turn cause a further deterioration of the financial side. The internal transmission mechanism of this mutual feedback is the debt-deflation-default process, which also contains its own inter-causal feedback effects.
Rising real debt, deflation across the three price systems, declining cash flow and disposable income, and the corresponding collapse of available credit transmits to the real economy in the form of a rapid decline in business and consumer spending, which in turn feedback upon each other. A faster, deeper and more protracted recession results, not a ‘normal’ recession precipitated by external demand or supply shocks, but an ‘epic’ recession precipitated by a financial crash and accelerated by an endogenous condition of extreme ‘systemic fragility’.
As the bust phase of the cycle continues and recession deepens, Government Balance Sheet Fragility—already growing per forces noted in proposition #14 above—rises further as well, as government fiscal-monetary stimulus policies attempt to halt the downturn. However, GBSF is not without limits. Under particularly severe conditions of Financial and Consumption Fragility, attempts to halt the momentum of decline by means of tax cuts and spending may prove insufficient while nonetheless adding to GBSF. The result is an extended period of ‘stop-go’ recovery, with short and brief real economic growth punctuated by repeated relapses, and even double dip recessions. This ‘stop-go’ recovery trajectory may continue for years, and even decades, should Systemic Fragility rise or remain high.
Systemic fragility in its three basic forms, and their mutual amplifying feedback effects, transmit to the real economy by means of reductions in fiscal and monetary multiplier effects. In the attempted recovery phase, the State engages in fiscal stimuli to bail out banks, corporations and investors. However, Systemic Fragility means business tax cut multipliers have sharply declined, to less than 1.0. State fiscal stimulus consequently results in business, and especially Multinational Corporations, cash hoarding. Cash hoarded is then diverted to corporate stock buybacks and dividend payouts, diversion of real asset investment to offshore emerging markets, and into new financial asset speculative investing in an effort to resort collapsed asset values and corporate balance sheets. Real investment and thus job creation subsequently lags and a stagnant stop-go recovery results.
Proposition 19: Systemic fragility and its amplifying effects also serves to reduce money multipliers. Massive money supply injections by central banks are initially hoarded, then redirected to lending offshore, to financial speculation, and to ‘safer’ large corporations. Banks reduce lending to ‘less safe’ smaller businesses and households, further reducing investment, jobs and consumption demand. Money demand and money velocity thus offset money supply injection by central banks. Central bank QE and zero interest policies provoke instead new financial bubbles in stocks, junk bonds, real estate, foreign exchange and derivatives trading. Currency wars erupt as money injection policies depress currency exchange rates. Banks and financial markets become increasingly addicted (dependent upon) central banks money injections. Globally, financial speculation raises the specter of further financial instability on a real economy base further weakened by the preceding cycle of economic contraction. The risk of bona fide global depression rises in time.
In the context of conditions noted above—of systemic fragility and growing feedback amplitude effects—traditional fiscal-monetary policy tools attempting to expand the economy are rendered increasingly ‘inelastic’ (i.e. less sensitive or effective) in generating a sustained economic recovery. Conversely, when such tools are employed to contract the economy, via austerity fiscal policies and/or central bank raising of interest rates, the effects are more ‘elastic’ (i.e. more sensitive and effective) in contracting the real economy. Fiscal-monetary policies are therefore not simply increasingly non-productive but, over time, become counter-productive in generating recovery. Solutions to recovery consequently lie in the necessity of a major restructuring of the economy along multiple key sectors including, but not limited to, the tax system, banking system, retirement and healthcare systems, labor markets and public investment—with the purpose of redistributing income while simultaneously reducing debt. That is, reducing systemic fragility in aggregate as well as its mutual amplifying effects.
Jack Rasmus, copyright April 2013