The Failure of Capitalism

Capitalism as a concept has sure taken a beating lately, although it is not dead just yet.  It’s not really a bad economic system either, as far as systems go.  But, it’s an under-achiever, because it will always seek to destroy itself.  That’s the take by the late Hyman Minsky, a contrarian economist who predicted this economic crash, even though he died over a decade ago.  Minsky was misunderstood during his time, and remained a reclusive figure in the world of macro-economics, although now economists and journalists are seeking out his insights.

In free market theory, the “creative destruction” of capitalism should always weed out the weak and unproductive elements and promote what works best, steering the economy to ever-greater heights.  According to this model, no King, Czar or government regulator can properly achieve this equilibrium, because to manipulate this equation is to destroy it.  Minsky believed in this model of free markets, but he also believed that human nature would always sow the seeds of instability, eventually causing the system to crash.  In fact, it’s the very stability of the economy that causes the crash. 

Here’s why:  When the economy is doing well, speculators should be satisfied with their take, but they never are.  They always attempt to ramp up the risk in an attempt to make even more money.  A stable economy, especially an economy as stable as ours was for a very long time, becomes, in Minsky’s words, a “euphoric economy.”  One in which “success breeds a disregard for the possibility of failure.”  Given enough time and enough euphoria, excessive risk becomes the everyday business model, until the economy becomes a Ponzi scheme, with more borrowed money out there than there is value or capital to pay it back.

At some point, something triggers a panic, at which time everyone realizes, at roughly the same time, that the economy isn’t wearing pants.  Then, everyone tries to shed their debt, and prices and asset values plummet.  That is what is now called a “Minsky moment.” Before Minsky died in 1996, he warned that public and private debt was getting out of hand, and that securitization of debt and other exotic financial innovations would lead to a crash.  Indeed, he was correct.  His so-called “Financial Instability Theory” was so complete, it even theorized about what must be done to clean up the mess. 

He called for the Federal Reserve to step in as the lender of last resort to restore liquidity.  He also called for “priming the pump,” creating lots of work projects requiring skilled workers.  These two things have been done in this crash, saving us (maybe) from even worse consequences.  The third part of Minsky’s recovery plan has not been done and will NOT be done.  That was to create a program to provide stability to the lowest levels of the economy by providing work for the poor and unskilled.  That would provide a “floor” to the economy and create wealth that would “bubble up” through the system, creating benefits all the way up.  

This part of Minky’s plan would be far too socialistic to have any political traction today, and I would not dare advocate it for fear of being pilloried.  My gripe is that we have become far too content with trickle-down economics.  Corporate welfare is accepted as a necessary evil, but public welfare is to be despised.  The “too big to fail” banks are even bigger, people with enough money to speculate are back at it, as is seen in the rise of the stock market.  In the real world, many are worried about making it to the next paycheck. 

Absolutely nothing has been done for the average American family, most of whom were innocent bystanders, or “collateral damage” in a class war that’s re-arranging the loot in favor of the ultra-wealthy.  We might be the first generation to never retire, because our retirement savings are now being used to send the kids to college and pay the mortgage, and social security will be wiped out by the time we get there.  Not that we’re looking for a handout or anything, we are just understandably upset that our hopes and dreams, not to mention our honest work, have been vandalized by those that inhabit the world of uncontrolled greed and speculation.

Minsky was marginalized during his time because his theories did not fit neatly into the prevailing economic schools of thought that have held sway in recent times.  One is the “Keynesian School,” (after early 1900’s British economist John Maynard Keynes) that government must smooth out some of the bumps of a market economy.  The other, the “Chicago School”, are believers in legendary free marketer Milton Friedman.  The Keynesians ruled economic thought in the 60s, to the extent that a Time magazine cover story in 1965 declared “We are all Keynesians now”.  In that time, the record broadly based prosperity was understood to have resulted from careful government guidance of the economy.  Even Freidman and Richard Nixon were both credited as having made similar claims.

But the Keynsians were badly mauled in the 80s by Friedman and the Chicago School (read “Reaganomics”).  By the 90s, Keynesians were lying so low it was hard to tell where or who they were.  During 20 years of the systematic dismantling of financial regulation, the silence of the Keynesians, such as Nobel economist Paul Krugman was deafening.  After the meltdown, however, as giant corporations were bailed out, the phrase “We are all Keynesians now” suddenly reappeared as the headline of a Boston Globe editorial.  In its current use, it meant hardcore free marketers were in the difficult and embarrassing position of explaining why they needed to be bailed out.  Or, to put it another way, there are no capitalists in foxholes.

What to do when economists admit they have no idea what’s going on?  A catastrophic failure of this magnitude has defied explanation by any of these economic models.  In fact, the entire profession of economics, and a hundred or more years of economic thought, has been turned on its ear, if not even rendered null, void and useless.  The long era of uninterrupted growth had most economists believing they had entered a golden era, where all the conundrums had been solved and the economic model was a thing of beauty.  Paul Krugman himself, in a recent New York Times article entitled “How Did Economists Get It So Wrong?” admits “It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty…”

The great unsolvable question still remains: How did everyone get it so wrong?  The crushing debt loads, the insane leverage, the business models based on sheer lunacy.  The required suspension of disbelief by millions of smart people over decades of time is hard to think about.  Rivaled in history perhaps only by that which was required for the Holocaust to take place.  Face it – government, Wall Street, the Fed, have no idea what they are doing.

The Obama administration came in riding a message of “change.”  Even if they wanted to, they were certainly in no position to change the financial juggernaut they were handed.  To see the seamlessness with which the bailout and recovery operation was handed from Bush to Obama, and to see the way Obama assembled his economic team, it was pretty clear that Obama’s marching orders came from the Fed.  The Fed and Wall Street did the only thing they know how to do, they recapitalized the wealthy.  So money is again flowing, but only in the most stratospheric levels of finance.

Capitalism is not dead, but it may be mortally wounded.  The stock market is running hot now because of all the money injected from bailouts and Fed loans.  But the free market economy depends on a successful working class and middle class sending their money up the ladder.  With so many families struggling for survival, those segments of the economy that rely on consumer spending are going to be in trouble.  The next perfect storm is this: $3 trillion dollars of excessive commercial expansion will become due for refinancing in the next few years.  That will happen in a climate where both credit and consumer spending are frozen stiff.

Greed is, in the end, the only real explanation, everyone knows that.  In their greed, the free marketers have goosed the system till they killed the golden goose.  That is the failure of capitalism.

Doug Friesen

9/22/09