Socialism for the Rich--Capitalism for the Rest of Us

James Grant, the editor of Grant's Interest Rate Observer, writes today in the New York Times:

Why does the Fed feel the need to intervene at the drop of a market? The reasons have to do with an idea set firmly in place in the 1930s and expanded at every crisis up to the present. This is the notion that, while the risks inherent in the business of lending and borrowing should be finally borne by the public, the profits of that line of work should mainly accrue to the lenders and borrowers.

The Fed intervention was to print-up $78 Billion in new crisp dollars bills, and lend them to the banks in exchange for their bad mortgages. Not a bad deal--for the banks. For the public, who has to bear the expense, it is a different matter. However, since they lack representation at the Fed and have no lobbyists in Congress, the public may be safely ignored. Of course, the bankers who borrow this money to cover their losses are the same one's who pound the table about "free enterprise" and "get the govmint off our backs." At the first sign of trouble, they become instant socialists, so long as they are the beneficiaries.

But I am not ranting on that question today so much as asking how we got into this situation. Or rather, why we keep getting into this situation, since this is a recurring pattern in capitalist economies. Grant traces this corporate socialism back to the 1930's, but in fact it is much older than that. Adam Smith offers much the same analysis of corporate welfare in The Wealth of Nations, first published in 1776. Why does capitalism seem to depend on socialism for the rich and "free" markets for the rest of us? Why do we see the pattern over and over again? There is indeed a reason. Capitalism tends to concentrate wealth at the top of the social scale. However, this excess concentration creates a problem that even the founders of standard neoclassical economics noted. As wealth concentrates, it has more and more difficulty in finding profitable investments. Indeed, the concentration of wealth all by itself narrows the markets. Markets depend on a broad base of consumers with sufficient purchasing power to clear the markets of all the goods and services produced. But concentration narrows this base and hence makes investments more risky.

In order to get a decent return on their money, investors must accept higher and higher levels of risk. That is, loans become riskier as credit is extended to a broad public that has reduced means for repaying its debts. It is not that bankers and others are simply foolish men; by and large they are shrewd men. Rather, it is that they have no choice. The narrowing of the broad base of the market increases the risks of investment, and the excess capital has to go somewhere. As the investments get riskier, the risk premium itself disappears, and there is less and less difference between the rates for a risky loan and a sound one. But while the risk premium disappears, the risks do not. Eventually, the risks come home to roost: loans default and fortunes are lost.

Or at least, that is the way it works for you and me. We can lose our fortunes, our homes, our livelihoods, and that will be regarded as nothing but the normal risks of living in a capitalist country. However, for the rich who created the problem, it is otherwise; they have the power to command the government to absorb their losses, while they themselves get to keep the gains. The truth, however, is that this cycle cannot go on forever. Sooner or later, the whole house of cards collapses, with catastrophic results. We have come to the belief that such collapses cannot happen here, that the bad old days of the Great Depression cannot again come.

I hope they are correct. But I suspect this is a fantasy. While the govmint may make small changes to correct small problems, I suspect that this merely builds up pressure to create a problem not even the omnipotent govmint can handle. What it mainly does is convince the rich that there is no more risk, or rather no risk that the govmint won't take off their hands. This was somewhat effective in the day when the United States was a creditor nation, the dollar strong, and we produced most of the goods that we consumed. But it is no longer true. We live on borrowed money, and the nation that lives by borrowing lives on borrowed time.

2 comments:

Comrade Andrey Friday, August 31, 2007 at 8:23:00 PM CDT  

great post, john. it has just been the last few months that i have come to discover distributionism and its greatness. i know that you and other friends of the league face those that are catholic and wholeheartedly for capitalism against what the popes' encylicals have outrightly stated. it reminds me of the neo-con catholics that support the war in iraq even against the statements by
both jp2 and benedict.
may you be encouraged and please continue your writings.
God Bless!

Anonymous,  Friday, October 3, 2008 at 8:56:00 PM CDT  

nicely said my friend. I have thought about all this and could not put it together. You make a great point...and a sound one too. Because we are all scared we hope that the bail out plan is actually a good thing and will keep credit going. But somehow, it just does not sound right. And in situation of fight or flight (which is where we are right now), we need to trust our guts...and socialism for the rich does not sound American to me. Or is it? Is this what we're all about?

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