Origins of the crisis

The IFS says:

The last decade as a whole was characterised by a very poor performance for average incomes. Between 2002–03 and 2009–10, no single year saw an increase in median income of  more than 1.0%.

This reminds us of something I fear is often forgotten - that our economic troubles did not begin with the financial crisis of 2007-08 but rather pre-dated them.

My chart shows this. It shows that firms were loath to invest long before the crisis. Capital spending fell relative to retained profits in the early 00s and stayed very low by historical standards. This reflects the "dearth of domestic investment opportunities" in western economies of which Ben Bernanke spoke in 2005. This is, of course, a cause of the weak income growth of which the IFS speaks; firms' reluctance to spend held down wage and employment growth. The "Great Moderation" might have led to irrational exuberance in financial markets, but it certainly did not unleash a boom in corporate animal spirits and real investment.

In fact, one could argue - as Ravi Jagannathan has (pdf) - that the financial crisis is not the cause of our woes but rather a symptom of this underlying problem. The story goes something like this.

After 1997, Asian economies wanted to run big current account surpluses, either as a policy of export-led growth or in order to rebuild reserves depleted by the 97 crisis. By definition, this meant they were net savers, which put incipient downward pressure upon global interest rates. In a parallel universe, these high savings might have financed a boom in real capital spending in the west. But because firms couldn't see good investment opportunities, this didn't happen.Instead, the lower interest rates fuelled a housing boom and the hunt for yield led to strong demand for mortgage derivatives. These bubbles in housing and derivatives then burst, giving us the crisis.

In this way, we've seen what Marx saw in the 19th century - that a lack of profitable opportunities in the real economy pushes people down "the adventurous road of speculation, credit frauds, stock swindles, and crises."

I say all this as a corrective to a common view on the non-Marxist left - that our economic problems are due to greedy bankers and to austerity. But this is nothing like the  whole story. This has been a crisis of real, and not just financial, capitalism - which is why it is so intractable.

Comments

[Luke]

Is there a way of telling if there are no investment opportunities for western business, or if there are opportunities, but for some reason managers don't spot/take them?

For example, someone starting in business in the 80s and used to 10% interest rates might subconsciously look for higher rates of nominal return than are realistic right now. But my real query is can we tell if capitalists are starved of opportunity or stupid/chicken?

[Alasdair]

I wonder to what extent this is self-fulling, i.e. because companies can't find productive investment thy refuse to invest and search for yield elsewhere, creating property/asset bubbles and resulting busts and instability, which in turn prevents the formation of productive opportunities. That is, to what extent is this just a self-reinforcing cyclical or random effect, and to what extent is it exogenous or the result of more fundamental changes in the economy (e.g. an increasing organic composition and so on). And therefore, to what extent could government intervention fix the problem?

[Metatone]

To extend Luke's point - it's very much "thinking like an economist" to be happy with the statement "companies didn't invest - therefore there was a dearth of domestic investment opportunities" - however if we're to begin to understand this we really need some kind of mechanism that explains why this might be so. Then we might have some notion if it is a "new normal" or a blip...

[Jock Coats]

Maybe confirmation bias on my part as a not very well-educated "Austrian" but the two precipitous falls appear to me to coincide with episodes of aggressive interest rate shunting by the central bank - in the first case over the ERM shambles and in the second when Eddie George cut rates to try and avoid a recession post dot-com. The difference between the two being that in the first case domestic borrowing for investment (i.e. in housing) went the same way as rates rose artificially high and in the second it went the opposite way as artificially depressed interest rates encouraged housing and consumer debt. Keynes's "animal spirits" can be easily explained then as would be investors left utterly confused about the disequilibrium in the loanable funds market and unable to model asset values accurately.

[Staberinde]

Or perhaps we now live in a time when there are so many tools to measure performance and ROI, and so much oversight, analysis and regulation, that it deters companies from taking the risks they might have done in previous decades?

And similarly, the mantra "you can't manage what you can't measure" might effectively crowd-out the desire to invest in innovative opportunities where metrics and analysis are in shorter supply?

Perhaps as the quantity and quality of information available to markets improves, risk becomes more quantifiable and easier to avoid. For years, we've encouraged entire industries to develop around the concept of mitigating and avoiding risk, all the while ignoring the fact that without risk, there can be no reward?

[Blissex]

«these high savings might have financed a boom in real capital spending in the west. But because firms couldn't see good investment opportunities, this didn't happen. Instead, the lower interest rates fuelled a housing boom and the hunt for yield led to strong demand for mortgage derivatives.[ ... ] greedy bankers and to austerity. But this is nothing like the whole story. This has been a crisis of real, and not just financial, capitalism - which is why it is so intractable.»

Sometimes when I read arguments like this I burst out laughing because they are so completely divorced from reality.

Of course there has been for the past 20-30 years a "a boom in real capital spending" fueled by companies seeing "good investment opportunities", and this had lead to a colossal jobs and wages explosion in China, Korea, India, Taiwan, Malaysia, and in a rather different form in Greece and Spain...

Wages and employment have been going up by 10-15% a year for decades.

This has happened because transnational companies are ruled by (somewhat fake) spreadsheets, and if the spreadsheet says that an investment in Shenzen will return 20% and one in Yorkshire will return 15% no corporate manager on the make will "champion" the Yorkshire investment, because the "champion" of the Shenzen investment will be the one who gets the bonus and gets promoted. Whether the numbers are real or not the spreadsheet rules.

Extremely loose monetary policies in "anglo-american" style political cultures have deliberately subsidized the liquidation of productive capital in those cultures and funded the creation of vast amounts of new productive capital in China, India, Korea, Taiwan, ...

I don't have much respect for arguments that are rigorously based on ignoring that capital is transnational and that extremely loose monetary policy has indeed had the obvious effects, by ignoring the rest of the world.

[Mayson Lancaster]

How much of the decrease in the ratio is due to the massive rise in profit's share in corporate revenue? It seem to me a more consistent measure would compare capex to revenue.

[Blissex]

«compare capex to revenue»

But again, capex *where*? In the USA/UK/... or in China/Korea/...?

Because again what matters is *relative* returns.

For all we know there are many investment opportunities in the UK at 15%, but those in China deliver 20%.

Thus championing capex in places like the UK has been a career-ending move for decades, given the relative returns. Conversely, asset stripping and liquidation in places like the UK has been a very profitable career-boosting move.

In places with a different culture like Germany given a local investment returning 15% and an offshore one returning 20% the local one still often gets done, because it is profitable enough, and the corporates there think they are strategically invested/have sunk costs at some level in their home country, probably because they regard themselves as productive businesses.

Anglo-american culture corporates are instead rather location independent, probably because they regard themselves as trading businesses, buying low wherever it is lowest and selling high wherever it is highest, day by day if possible; to them productive capital is just friction, ballast, in their trading strategy.

Very abundant liquidity ("fictitious capital") at very low rates make capex inexpensive allowing "trading" oriented companies to switch place where they buy low quite more frequently, chasing even smallish differences in relative returns.

The Chinese in particular have been very good at playing the game of rigging the spreadsheets of USA/UK/... companies, especially by keeping their currency lower than it would be by repressing consumption, thus "helping" the spreadsheets of USA/UK/... companies drive ever "deeper" and longer term capex to China. And once that is done it is hard to undo.

[Mick Beaman]

....didn't David Harvey make this point at length in Limits to Capital?

[Jan]

Bernanke may have borrowed from Marx but Marx borrowed from Malthus.

This column sees the iceberg, which is better than most economists, blinded as they are by their neo-classical indoctrination, but it only sees the tip.

A few economists understood why the eurozone (aka German neo-mercantilism) would not work: monetary unification without fiscal unification. But hardly any of them have the courage to understand why globalization does not work: market consolidation without monetary and fiscal consolidation. (And perhaps, if the sociologists are right, also without communal or cultural consolidation.)

You thought the Cold War was wild and scary? Compared to the hard realities of global economy, the Cold War was tame.

[fledermaus]

Why bother with capitial expansion that may not pay off for years when you can just borrow at low rates and use stock buybacks to goose the headline numbers instantly. It's a sure thing and doesn't involve any work.

[Peter K.]

Blissex's focus on loose monetary policy is really, really weird, if not crankish.

I would be in favor of financial transaction taxes rather than hard money. The UK, the US, Europe and Japan should all do currency devaluations to help boost exports. Currency policy determines the current account balances, not monetary policy. Loose monetary policy would help lower the currencey: See Japan.

The Chinese are giving the US cheap loans. We should employ those loans for rebuilding infrastructure and stimulative fiscal policy but conservatives are blocking that. Instead they're forcing fiscal austerity.

I would add a couple things to the grand narrative. Dean Baker has pointed out Asian countries built up their reserves in part because they wanted to make sure that they would never have to go to the IMF for help. (See Greece.)

Also, before the crisis the financial system turned mortgage-backed assets and repo agreements into safe assets which earned more than government bonds. This helped blow the housing bubble. When it turned out these safe assets weren't that safe, it caused a run on the shadow banking system which wasn't insured by the government (except via ad hoc bailouts).

[Peter K.]

"In this way, we've seen what Marx saw in the 19th century - that a lack of profitable opportunities in the real economy pushes people down "the adventurous road of speculation, credit frauds, stock swindles, and crises."

There's also the American economist Minsky who focused on how during the height of a bubble people are overconfident and reckless. This leads to a lot of fraud and speculation and finally a crisis or "Minaky moment" when euphoria turns to panic.

[Blissex]

«focus on loose monetary policy is really, really weird, if not crankish.»

Michael Pettis has devoted nearly a book to the topic, "The volatility machine". A pretty serious book. One of the central points he demonstrates is that there are recurrent periods of loose regulatory and monetary policy in what he calls "core countries", and these periods drive booms and manias around the world.

«The UK, the US, Europe and Japan should all do currency devaluations to help boost exports.»

That's more than crankish, it is delusionary.

Suppose that the USA, Europe and Japan, which are the biggest economies on the planet, all devalued by the same amount to export more: to whom? To North Korea? To Afghanistan? To Somalia?

The problem is that exports are driven by foreign demand and by *relative* exchange rates.

If the biggest economies of the world all devalue their relative exchange rates don't change, and if you know of countries who have the means to buy much increased exports from all of the largest economies of the world at the same time, please let everybody know.

[Luke]

Bissex, fair point that,say, china is a more enticing prospect than Rotheram. But that doesn't explain why capitalists are reinvesting less of their profits. Why are they reinvesting less (whether in Rotheram or China6)?

[George Carty]

«Suppose that the USA, Europe and Japan, which are the biggest economies on the planet, all devalued by the same amount to export more: to whom? To North Korea? To Afghanistan? To Somalia?»

They probably wouldn't export more, but they'd import a hell of a lot less from China, India and other low-wage countries. Which is kind of the point isn't it?

[Blissex]

«china is a more enticing prospect than Rotheram. But that doesn't explain why capitalists are reinvesting less of their profits»

Note that what we are discussing here is *first-world* capitalists, not capitalists as a whole. My overall theme is that looking only at first-world economies when capital is transnational and after the end of the cold war is not very useful.

Anyhow that's a good question, but it is quite distinct from my point about there being a *global* dearth of investment opportunities.

There are three distinct issues there:

#1 Has there been some kind of "dearth of investment" by first-world businesses?

#2 Has there been some kind of "dearth of investment *relative to profits*" by first-world businesses?

#3 Is there a "dearth of of investment *opportunities*" for first-world businesses?

#4 Is there a "dearth of *domestic* investment *opportunities*" in first-world countries?

My argument has been that #1 seems ridiculous given how eagerly first-world businesses have invested in third-world countries and how this has resulted in huge increases in employment and wages in third world countries, for *decades*.

Consequently #3 seems ridiculous as well, as the availability of large low cost labour pools in unregulated and corrupt third-world economies seems to have created a lot of investment opportunities (and disinvestment opportunities from first-world countries). As the Economist recently admitted, of course domestic disinvestment and foreign investment (called "offshoring") in the past few decades was entirely about labor arbitrage.

Also my point is that that #4 is not necessarily related to #1: because there might be profitable investment opportunities in first-world countries, just not as profitable as those in third-world countries, at least in the short term.

Whether #2 is true is hard to say, as what constitutes "profit" and what is "global" investment by first-world domiciled companies are difficult questions given also how difficult is to find reliable data.

I wouldn't be too surprised if it turned out that overall profits of businesses based in first-world countries have outpaced their *global* investments, as the availability of a larger cheaper labour pool would have reduced the desired level of capital intensity.

[Blissex]

«a lack of profitable opportunities in the real economy pushes people down "the adventurous road of speculation, credit frauds, stock swindles, and crises."»

But all that is needed for that effect is a lack of *relatively less* profitable opportunities in the real economy.

One of the biggest ifin the not the biggest trend in the past 30 years has been extremely loose credit policy, which as taken the form of both loose monetary policy and loose regulatory policy, driving ever increasing debt-to-GNP ratios.

In particular perhaps the biggest trend has been the growth in financial business leverage ratios first from 10-15 to 50-60 and currently to infinite as most large financial businesses (and not just in the first-world) have no or negative capital.

Only suckers in anglo-american culture first-world economies have been investing in non-financial businesses in the past 30 years, given the extraordinary ROI consequent to ever increasing leverage ratios and availability of unlimited, very cheap liquidity to those financial businesses.

There may be pretty good opportunities in the real economy, or perhaps not, but anglo-american culture governments have been massively pushing and subsidizing "speculation, credit frauds, stock swindles, and crises" making them far more attractive than any boring, slow investment in the real economy.

[Blissex]

«They probably wouldn't export more, but they'd import a hell of a lot less from China, India and other low-wage countries. Which is kind of the point isn't it?»

That's called "austerity" and it is the strategy that the Tories have chosen for the UK: large reductions in labour living standards (around 3-5% per year for a few years now) by holding wages constant in nominal terms while devaluing the pound as much as possible, to ensure that workers buy less of the imports that make up a large part of their living standards.

That strategy is one of the two possible, the other being pushing up unemployment and down nominal wages, as being recommended to Ireland, Greece, Latvia, etc.

Note that the topic of this post is "The last decade as a whole was characterised by a very poor performance for average incomes".

You are simply advocating more of the same. George Osborne obviously agrees with you :-).

At least who wrote «The UK, the US, Europe and Japan should all do currency devaluations to help boost exports» hoped this wishful thinking would be an alternative to austerity.

The basic point by some ancient bearded economist was, to simplify a lot, that capitalism suffers a contradiction between the interests of capitalists and those of capitalism: each capitalist wants low wages and high sales, but given that wage earners are also consumers, if all capitalists succeed in driving wages down, they also kill their own aggregate sales.

Each capitalist therefore dreams of driving down the wages to their own workforce, while the wages paid by other capitalist stay high. Offshoring and competitive devaluations are two of the strategies they use for this.

[paulc]

@Blissex"One of the central points he demonstrates is that there are recurrent periods of loose regulatory and monetary policy in what he calls "core countries", and these periods drive booms and manias around the world."
so there's a correlation [possibly] between periods of loose monetary policy and lax regulation and subsequent crises and crashes. What is important though is which way does causation run. Is the loose monetary policy/lax regulation a function of a moribund 'real' economy. Which itself is a function of the capitalist system which gets progressively lower rates of financial return throughout the cycle and over longer periods of time without the benefit of big technological innovations[computerisation 50's to 70's]or other fixes [women joining the workforce-globalisation-credit binges].

The data on rate of profit is difficult but nonetheless there is much work done on this area which suggests that it is indeed a falling rate of profit which precedes and underlies the the proximate triggers of loose monetary policy and lax regulation. Michael Roberts develops this line of argument in his own blog.

[Blissex]

«there's a correlation [possibly] between periods of loose monetary policy and lax regulation and subsequent crises and crashes»

That's more or less Minsky in a sentence.

«which way does causation run. Is the loose monetary policy/lax regulation a function of a moribund 'real' economy»

Well, Minsky seems to think that is sort of pro-cyclical, not counter-cyclical: while things are good policy becomes ever more favourable to speculation, and I think that has happened frequently.

«it is indeed a falling rate of profit which precedes and underlies the the proximate triggers of loose monetary policy and lax regulation.»

I think that happens too, but more rarely than pro-cyclical policy.

Going back to «a very poor performance for average incomes» I think that for several decades now there has been a severe unemployment crisis in first-world economies, where employment has been supported by creating many jobs that produce no value added, for example in the financial sector, but not only.

To the point that B. Obama himself has been defending the fact that in the USA healthcare costs 14% of GDP instead of 7% of GDP in most other first-world countries by noting that the extra 7% may be waste but that waste is the jobs of a lot of people.

[Blissex]

«Offshoring and competitive devaluations are two of the strategies they use for this. [ driving their own wages down without driving their sals down ]»

Recent events show that they have added two other techniques, both based on selling on credit.

* Stupid capitalists, or those like managers who don't care about keeping their businesses alive, do direct financing or vendor financing. Here wags are kept down, but sales are funded by debt issued by capitalists themselves. When the debtor are revealed as insolvent, the vendor financing capitalists go bust.

* Clever capitalists, well taught by by Greenspan, prefer that sales to their low paid workers be financed by stooges who lend to consumers against worthless collateral. The game here is that the government creates a "wealth effect" on consumer demand by pumping up some bubble or another, and then leads banks to lend against the newly bubbled up collateral, and during the dump phase when the collateral vanishes uses "austerity" to make workers bail out the stooges.

AS to the latter one of the most amazing details of propaganda of Greenspanian, "aligned", economists is that they talk a lot about the demand boosting of the "wealth effect", but never of the demand boosting of the "income effect". Because boosting demand by increasing incomes of consumers, instead of their debts, is "inflationary", by which they mean it reduced profits.

[Boffy]

The chart shows the percentage of capex against retained profits. But, this does not necessarily mean that capex was falling absolutely, or that there was a dearth of opportunities. If, as I believe the facts demonstrate, the rate and volume of profit was rising - and I would add the rate of turnover of capital was rising sharply due to technological innovations like the Internet - then it is quite possible for capex to be rising in absolute terms, but falling relative to those growing volumes of profits.

Then you get money hoards building up, which also leads to falling interest rates - remember according to Marx interest rates are determined by the demand and supply for capital not money, and so money printing is only the means by which this surplus capital manifests itself, and not in itself the cause of the 30 year secular fall in global interest rates - which then circulates within the circuit of money blowing up asset price bubbles.

I believe that is wholly consistent with the conjuncture of the Long Wave - Winter from mid 80's, Spring from 1999, Summer just starting. I also believe that is consistent with the demand and supply balance of capital now shifting leading to the end of the 30 year bull market for bonds, and what we see in terms of now rising global interest rates i.e. the rate of profit declines from here,the supply of capital declines relative to the demand for capital.