Box Score: Money 2, Value 1

Coming of age in the Reagan era, I failed to understand what I was witnessing. America abandoned manufacturing for services and ended up in a time warp.

As a corporate-level software consultant, my father Karl saw elements of this up close. Invited as a fellow traveler by the president of Wiley & Sons (the journal publisher), Karl sat in on the annual shareholder meeting. A careful investment plan charted growth in assets and employment. During the discussion, the CFO queried, “And what is the annualized rate of return on your plan?” With the follow-on to the response, “I can take that same money and make three times as much in the stock market.”

In that era, the stock market still reflected an investment in other people’s ingenuity. This year, as we approached the election, one Trumpie threatened, “Well, if Biden wins, you can be sure the stock market is going to tank!” The inescapable corollary is that the stock market is no longer an economic bell-weather but an instrument of political influence.

That influence is maintained through the ties between the Federal Reserve and the large banks. We are in the mind-numbing reality that the people that take care of our money no longer profit from making it grow, they profit by making it move. That may seem impossible, but the volume of real estate, trade, and government debt is so enormous that simply the placement fees run into the tens of billions of dollars annually.

The bind for the public is that the money center banks hold no interest in seeing the debt reduced. In fact, the Dow weathered recent financial crises because the Federal Reserve issued borrowing authority that the banks loaned to corporations to buy back stock. The value of stock is now linked to corporate debt.

And in the chaos only the financial system has a guaranteed benefit.

Was this intentional? Hardly, but it was inevitable. This is trumpeted by the liberal economists, but they misdiagnose the problem. I hope with this post to steer them in the right direction.

The liberal economists blame “capitalism.” Capitalism, coined by Adam Smith, is a recent innovation, seeing an effective implementation only in the industrialization of the Western world in the late 1800’s. Capitalism was actually a liberalizing social contract. It held that money and labor could collaborate to improve productivity. Higher productivity meant more money for investors and lower costs for labor. It was a win-win scenario.

Capitalism disproved the precepts of Malthus, who held that population growth would always overwhelm the benefits of productivity gains. In part, however, Malthus was proven right because political power was held by the moneyed noble class. Market control was awarded by royal writ, and once secured ensured resistance to innovation that might lead to diversification of supply. Stability of prices was also important to the nobility and their retinues, often sustained by stipends.

The crack in this hermetic system was warfare, and it was to finance their conflicts that the nobility turned to the banking system, leading to the coupling of political and financial interests that suppressed the development of liberal societies.

So the “Box Score” reads as it is because capitalism is now revealed as a brief interlude in the narrow marriage of politics and finance. It was an interlude during which finance married itself to the production of value and the growth of liberal societies.

Regardless of the outcome, the 2020 election proves at least one thing: that Donald Trump is a symptom, rather than a cause. The disease that created him is a return to the festering myopia of political and financial calculations freed from a concern for value or sustainability. Trump is used as a tool by that system to distract attention from the wizards behind the curtain. He is a live facsimile of the special effects in the Wizard of Oz.

How does this manifest in practical terms? Consider real estate. I was told recently that I had to get in the market, because prices would only go up. Looking over the finance package, I noted with surprise that is allocated 50% of my income to real estate costs, rather than the 30% typical of my youth. So the reason that real estate prices are going up is because the Federal Reserve, through Fannie Mae and Freddie Mac, is issuing loans that allocate more of our income to the payment of interest. The increase in home prices has nothing to do with value – it follows from a systematic manipulation of political and financial levers to ensure that we are indebted.

But the fault is not with capitalism. Capitalism was a God-send. The fault is with something I would call “monetarism” – the pursuit of wealth in the absence of any concern for value.

The economic historian should recognize this plague. What should give pause to the rest of us is the proof, in the results of the 2020 election, that the disease is worse that an out-of-control pandemic that has the potential to kill millions of Americans.

I hope that our democracy survives while our liberalizing politicians adapt to that lesson.

The Currency of Understanding

Sylvia Nasar’s Grand Pursuit traces the history of economic thinkers from Marx to the modern era. I say “thinkers” because Nasar present a series of historical and psychological sketches of those that generated the ideas that most profoundly influence modern public debate about the management of economies. This is not a book for those seeking to understand economics.

But for those involved in public policy debate, I would characterize Grand Pursuit as essential reading. It is one thing to talk abstractly about the relative merits of economic and fiscal policy. It is quite another to confront the historical context and moral concerns that drove the currents of economic thought. During the era that Nasar considers, Western civilization was confronted with profound existential threats. Economics was not about allocating the privileges of wealth – it was about preventing widespread loss of life through mismanagement that led to starvation and/or war.

The success of economics as a science is tied intimately to industrial entrepreneurship – to the process of incremental improvement that successively multiplies the value produced by individual effort. As Nasar documents, it was the observation of this effect that eventually gave economists the courage to believe that society could be liberated from ecological constraints.

In the agricultural era, the value of labor during planting and harvest so far overwhelmed the cost of survival that communities banded together to preserve their members. Parents taught their children almost everything that they needed to survive. Against this cohesion was mounted the vulnerability to environmental and political circumstance (drought or war could destroy the community), and lack of education that slowed innovation. Given the primitive motivations of the populace, economic thought was dominated by Malthusian precepts: any attempt to improve the lot of the lower class would result in increased birth rates, and an inexorable drop in wages to subsistence levels.

In the agricultural era, the stability of currency was paramount: sellers wanted to be certain that the currency they gained from selling grain one year could be recouped for equivalent goods in the next year. When governments abused this trust by printing money, economists concluded that money must be backed back a tangible good, such as gold. When industrialization and capitalism took root, the constraints on money supply choked the pace of investment. It took nearly half a century for economists to respond to the fact that currency was backed, not only by government-held gold reserves, but by the capital goods (machinery and buildings) that supported production, and the education and skills of the workforce.

One of the primary lessons of the history Nasar documents is that financial obligations are secondary to production, and that countries that effectively manage production (to wit: without undermining fiscal stability through inflation) almost always grow out of their obligations. Failure to recognize this opportunity entrained Europe in the terrible hardships following World War One and drove it inevitably to World War Two. (One might argue that we face this same problem today in the debtor nations of the third world.) The second prejudice to be overcome was the idea that each nation could chart independently its economic course. This should have been obvious to the colonial powers, but it was only when WW II ended that Europeans were forced to recognize that they would have to cooperate to ensure access to the resources that industrialization converted to consumer goods.

Nasar begins her survey with Marx and ends with Sen. This brackets the second great threat to the survival of Western liberalism: the proposal that planned economies were the only way to prevent economic collapse. This was not an idle question during the Great Depression. Unemployment depressed earnings, and as prices fell due to lowered demand, the value of savings increased, and the capitalist incentive to invest vanished. The Western economies were confronted with wasteful idleness of their productive capacity, and no means to stimulate demand. It was Keynes and others that encouraged governments to deficit spending and jobs programs that stimulated consumption. That eventually got economies rolling again, or at least it did in Europe – in America, FDR lost his nerve in 1937, and full economic recovery did not occur until the nation was forced to rearm under the threat of German and Japanese aggression.

The lesson of this history is that governments do not need to control all aspects of the economy. As long as leaders ensured demand sufficient to stimulate investment, individual initiative will produce the triple benefits of innovation, growth and – as falling prices outpaced population growth – increased wealth. The centrally planned economies of the East (principally Russia and China) were repudiated not by military power, but the basic laws of fiscal probity and industrial growth.

While Nasar does not articulate clearly the essential points of economic theory, that perhaps is just as well. The history makes it obvious that the greatest economists were pragmatists, not dogmatists. They were concerned principally with how things worked, not with abstract principle. They were driven by the desire to prevent, manage and recover from crises that political and economic parochialism wrought upon Western civilization.

I believe that this is why Nasar ends her survey with the economic moralism of Sen. The great thinkers of economics were successful because they cared enough to commit themselves relentlessly to study of the systems that secured the well-being of their countrymen. They confronted hardship, and felt deeply the need to overcome it. One would hope that their conclusions – that wealth can survive only when it is a tide that lifts all boats – would be appreciated better by economic and financial decision makers who have yet to have to face such crises. Else, as Santayana famously observed: “Those that cannot recall history are doomed to repeat it.”