Capitalism without Capital

Accounting for the crash

Alan Shipman

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN:
  9781349684380
  9781137442437
• eBook ISBN:
  9781137442444
• Topic: Economics
• Subtopic: Finance
• Index: Economics

Financial crisis, recession and worsening inequality have long been blamed on a surplus of capital. But the actions that led the latest boom and bust by banks and businesses, households and governments - can better be explained capital's increasing scarcity. Efforts to track it down confirm its disappearance.

1

An Obvious Excess of Capital

The idea that capitalism can work without capital is clearly absurd. It’s got to be there – not just by definition, but because economic activity is stalled without it. When just a few dollars’ worth of capital is added to poor people’s ingenuity and industry, it can unlock the commercial drive that lifts them out of poverty (Banerjee & Duflo 2011: Ch. 9, De Soto 2000, Yunus 2003). Plenty of informed observation shows that people on low incomes have the incentive and inventiveness to prosper, and it is for want of an – often tiny – endowment of capital that they remain stuck in a hand-to-mouth existence.

It seems equally obvious that richer countries have more capital than poorer ones, and that this explains their greater prosperity. To explain why residents of Lusaka, who know as much and work as hard as their equivalents in London, receive a fraction of the income, appeal is made to the better ‘capital equipment’ with which Londoners work and the stronger ‘social capital’ that surrounds them. Economic theory can easily show that it is extra capital that generates extra income. Additional ‘physical’ capital (capital equipment) raises the productivity of each activity, by extending its reach and enabling a more systematic division of labour. With it, people can engage in more ‘roundabout’ activity – preparing the ground before they till it, improving the reach of their implements and the quality of the soil when they till. Investment in new capital also drives and delivers innovation, creating new products and new techniques for better replicating existing ones. Additional ‘financial’ capital speeds up this expansion and upgrading of the means of production, especially by funding and reshaping the firms that organize production.

While there are also dissenting theories that suggest the rich have a need for more capital, rather than more capital making them rich, no-one seems to dispute the association. The labourer with a mechanical digger has (it seems obvious) more capital equipment than the one with a spade; likewise the clerk with a computer compared to the one with an abacus. A college graduate has more ‘human capital’ than someone their age who left school at 15. A networker has more ‘social capital’ than a loner. Oil- and mineral-rich Russia has more ‘natural capital’ than rocky Japan.

The world today (in 2015) is still emerging from a financial crisis that was widely blamed on there being too much capital. Analyses of this and several previous crises, whether conducted by friends or foes of capitalism, almost always conclude that modern capital is troubled by its own abundance, sometimes needing to be pruned or culled before it can rally and flourish again. This chapter and the next goes with the overflow, taking a brief tour of recent assessments linking economic downturn to excess of capital. The aim is to give them a fair hearing – and to cover the full range of definitions and measurements of capital – before proceeding in Chapter 3 to show that they may be wrong.

A tragic abstention: ‘global savings glut’

That the world was awash in surplus capital, looking for a safe place to park, was very clear to US Federal Reserve economist Ben Bernanke in early 2005. At the time the US economy was experiencing one of its longest ever upturns, growing steadily since 1993 with only a brief interruption in 2001. This left the Federal Reserve chairman, Alan Greenspan, grappling with an unusual problem. In June 2004 the Fed had raised short-term interest rates in order to slow the expansion, so that it would not be derailed by inflation due to excessive credit growth. But even when it raised the federal funds rate (then its primary monetary policy instrument), long-term bond yields continued declining. Capital was flowing into the market for ten-year Treasury notes and bonds, raising their prices and depressing their yields, when the combination of higher borrowing costs and officially expressed inflation concerns was supposed to send them the other way. ‘What is going on?’ the normally omniscient Greenspan was forced to ask (2009: 177).

Bernanke had a ready explanation for what was happening, which he made public at speeches in Virginia and Missouri in March and April 2005 (Bernanke 2005). A number of large and/or fast-growing economies, especially in East Asia and the Middle East, were saving more than they invested, and running large external surpluses. Their ‘exported’ savings were flowing into larger, longer-established economies, notably the US, where they drove down interest rates and lowered the yield on bonds and equities. Foreign investors bought more than half of the US$4.5 trillion of highly rated securities issued by the US in 2002–7, and more than 80% of China’s current-account surpluses were channelled into them (Bernanke et al. 2011). When Greenspan lowered short-term interest rates, which in principle should have made it less lucrative for foreign savers to buy US government bonds, they did not keep their money at home but simply switched it towards other, higher-yielding US assets, pushing down yields even on longer-maturity Treasury and private corporate bonds.

The global savings glut (GSG) argument usefully interpreted US economic imbalances – a wide fiscal deficit and comparably large current-account deficit – as signs of American strength rather than weakness that would only be reduced if other countries changed their behaviour. These countries viewed the US as a safer repository for their savings than their own economy, supposedly because of its bigger investment opportunities and better regulated financial system. So they exported ‘surplus’ savings to the US. The American current-account deficit was then the inevitable obverse of the resulting capital inflow – a consequence of US GDP outgrowing that of other advanced economies, and a perennially strong dollar making imports cheap.

Bernanke et al. (2011) anticipate the criticism that the GSG was insufficient to explain the whole of the accumulated US ‘twin deficits’, by pointing out that saving eventually became supplemented by borrowing. So successful was Wall Street’s financial engineering in creating ‘risk free’ high-yield products that some investors took out loans in order to buy them, anticipating that the yield would exceed their borrowing cost. This was especially the case in Europe, where governments’ efforts to reduce fiscal deficits in preparation for monetary union (in 1999) had depressed interest rates and bond yields.

Europe leveraged up its international balance sheet significantly, issuing, among other instruments, considerable sovereign debt and bank debt, and using the proceeds to buy substantial amounts of highly rated US MBS and other fixed-income products. In fact, the strong preference of the GSG countries for Treasuries and Agencies appears to have pushed Europeans and other advanced-economy investors, including US investors, into apparently safe ‘private-label’ MBS. (Bernanke et al. 2011)

European investors, in this view, took two additional risks in the US market which Asian and Middle Eastern investors tended to avoid. They diversified from government debt into securitized mortgage debt (believing, misguidedly, that its AAA ratings made it equivalently safe) and took leveraged positions, supplementing their purchases with borrowed money. Leverage not only multiplies any capital gains on an investment, but also multiplies any losses. Emerging-market investors, perhaps more alert to the possibility that credit rating agencies had overestimated the safety of mortgage-backed securities (MBSs), stuck with US government debt despite its lower yields. A popular explanation for this caution is that Asian investors were still raw from the experience of 1997–8, when asset price and exchange rate falls decimated their portfolios, and now prioritized the preservation of their capital over any clever strategies to enhance it.

Saving, investment and capital flows

Worries had surfaced before – after much shorter upturns – about global over-saving, arising from phases of sustained economic growth and putting a premature end to them. The Bernanke–Greenspan explanation of pre-2008 ‘global imbalances’ has been widely endorsed, even by analysts with very different economic and political outlooks. Lapavitsas (2013), from an avowedly Marxian perspective, blames the Federal Reserve for fuelling an asset-price bubble by keeping its interest rates low, but endorses the view that emerging-market savers played a key role in keeping credit unduly cheap even when monetary policy started to tighten. ‘The US bubble was sustained by reverse capital flows from developing countries . . . The poor of the world became net suppliers of capital to the US, keeping loanable capital abundant in the US markets during 2005–6’ (Lapavitsas 2013: 274).

‘Savings glut’ also translates easily into the macroeconomic accounting framework that regained popularity as economists sought to interpret the ‘international imbalances’ behind the GFC. Fast-growing emerging markets (plus those with oil surpluses and, anomalously, Germany) ran current-account surpluses because their savings (S) substantially exceeded their investment (I). Saving is simply income not currently spent. Investment is income spent with the intention of generating or enhancing future income, rather than just consuming in the present.

By macroeconomic accounting definition, an excess of S over I means that a country will not buy all the consumption and capital goods it produces, and will have to sell some abroad. Its exports (X) will exceed its imports (M), where these are broadly defined to include trade in goods and services, plus inflows and outflows of investment income and other current transfers. A savings surplus (S > I) must be associated with a current-account surplus (X > M), unless the country’s government absorbs all the private sector’s savings by running a fiscal deficit. If the government balances its budget, keeping its spending (G) equal to its tax receipts (T), then the savings surplus (S > I) will be fully matched by the current-account surplus (X − M).

All of this can be neatly summarized in the accounting framework

(I − S) + (G − T) + (X − M) = 0 ⇒ (S − I) = (G − T) + (X − M)

If G = T, (S − I) = (X − M)

[where S denotes saving, I investment, G government spending, T tax revenue, X current-account credits and M current-account debits].

Reckless savers, selfless borrowers

These are merely identities, making no statement as to what causes what. But the ‘savings glut’ hypothesis gives an appealing narrative, from the US perspective. Emerging countries do not invest enough in their own economies. That is partly because America, with its free society, strong property protections, developed infrastructures and wealth of human resources, is a good place to invest, offering relatively low-risk returns. It may also reflect the way that emerging countries’ saving is done mostly by an elite, which prefers to keep the resultant wealth outside the country. These countries’ governments, perhaps stung by the way that their credit line suddenly dried up during the 1997–8 ‘Asian crisis’, kept their budget deficits low, some even running consistent surpluses. So their private-sector surpluses were not offset by public-sector deficits, and instead spill out across borders, in the form of a current-account surplus inevitably matched by an outflow of capital.

The US then led the ‘free’ world in taking in that capital outflow – giving it sanctuary in the form of government and corporate stock and bond issues, or foreign direct investment (FDI) opportunities. In doing so, it inevitably ran a current-account deficit, which ensured that emerging markets could sell their net exports, and keep their surpluses sustainable. The US consumed more than it produced so that it could borrow the rest of the world’s excess savings, looking after them and letting them generate a return.

Before the ‘savings glut’ suggestion, foreign observers had often depicted the US as living above its means, borrowing from the rest of the world in order to finance consumption that perennially overwhelmed its production. The flow of savings from lower-income countries to the world’s richest economy was often presented as perverse, when lower income was commonly ascribed to lack of capital. Given that low national income had often been associated with a vicious circle in which low income meant minimal saving, and lack of saving denied the resources that could raise income, the US had seemed especially greedy in importing others’ savings instead of generating its own.

With a quantifiable savings glut, the apparent selfishness could be reinterpreted as generosity: the US is deliberately running up debts to the rest of the world so that other countries could avoid dragging their own (and the world’s) economy into recession through overblown thriftiness. Since savings-glut countries accumulated their external surpluses in US dollars, making it quickest and easiest to reassign them to assets in the same currency. The US offered them a particularly welcoming home through ostensibly open access to the world’s...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright
• Contents
• List of Tables
• Introduction
• 1 An Obvious Excess of Capital
• 2 A Still More Obvious Excess: Capital as Wealth
• 3 In Practice It’s Scarce
• 4 What Isn’t There? Capital Definitions and Measurements
• 5 The Destination of Wealth
• 6 Economics without Capital
• 7 Economies without Capital
• References
• Index