This is Not Your Father's Recession

Washington and Wall Street have finally discovered what everybody else already knew: we are in a recession. The political airwaves are crowded with bail-out plans and even the tone-deaf White House has heard the music. Now, this is nothing new. Since the end of World War II, the government has proven very good at “managing” recessions with a bit of monetary policy and fiscal stimulus. These basically Keynesian tools have kept recessions from becoming full-blown depressions. Washington hopes for a repeat performance, and a 60-year history of success gives them confidence that all will be well in a few quarters. Both sides hope to claim credit (in time for the elections) for the “recovery.” However, I am not convinced that history will repeat itself. Rather, we face a “perfect storm” in the economy, a storm that will swamp the standard analysis of these events and perhaps even force a crises of capitalism itself.

I believe that any economic theory has to provide good analytical tools, and that a theory can be judged in part by how well these tools work. Distributism is no different in this regard; if we cannot provide a better analysis, we cannot claim to have a better theory. Although Distributists have often avoided any “technical” analysis, my experience is that they actually have better tools, when they bother to apply them. Now is the moment to do this analysis, and to compare that analysis with the analysis of the standard economic theory. The standard analysis involves some variant of the so-called “Minsky Moment,” which reduces these shocks to psychology. Briefly, (and somewhat inadequately) in a Minsky Moment, investor's for some reason or other “pile-on” to some particular asset (technology, real estate, tulips, whatever) that is showing a higher return than other assets. As investment increases, risk premiums disappear and returns fall. Over-investment causes the asset values to inflate far beyond their “true” returns. Suddenly, the market catches up with the actual values, and the investments turn negative. The market is suddenly filled with more sellers and than buyers. Panic spreads beyond the specific market into the credit system itself, and there is a contraction of credit and with it, a contraction in economic activity. There are layoffs and a general contraction of demand. Such a crises in confidence is easily “managed” by having the Fed print up some money to shore up credit markets and having the government stimulate demand with extra spending or rebates. These are essentially the plans that are being debated now; they have worked in the past, and everyone expects them to work now.

I don't think that they will. I think the analysis fails to explain the reasons for boom/bust cycle. Certainly, there is a cycle of optimism/panic, but the “explanation” doesn't explain. Why do we have a an over-investment? Distributism provides an answer, and the answer is a lack of justice, specifically distributive justice. When workers do not get the full value of what they produce, then the wages they should have gotten end up going to the “top.” But this has two effects. One, there is an over-supply of capital, and two, there is a narrowing of the market (since the size of any market is given by the number of people who have funds with which to enter that market.) This narrowing market cannot support the funds available for investment. But capital must seek a return, and hence it ends up taking bigger and bigger risks. Risk premiums disappear, but risk itself does not. Eventually, the risks come home to roost, and the market collapses. For a more complete description of this process, see The Investor's Dilemma.

Since 1980, the median wage in this country has actually declined in real dollar terms. Yet, during the same period, worker productivity has exploded. This means that the worker is no longer getting the values he produces; the wealth created by increased productivity is all going the top. In other words, injustice has increased, and with it, so has instability.

But if this is correct, it is fair to ask why the policies of the standard analysis have worked up until now, and why they won't work in this case. I believe they worked not because of the reasons stated (“restoring the confidence of the markets,” etc.) but because they had a mildly redistributive effect, and this effect was strong enough to limit the damage. In truth, there must always be a distributive principle in any economy that is strong enough to balance supply and demand. When that principle isn't satisfied by the wage system, then other systems—redistributive systems—must be invoked or the economy collapses. Keynesianism uses a redistributive principle to restore aggregate demand and thereby balance supply. But since the Reagan Administration, Keynesianism has been under attack, and has actually become its own opposite: government power is used to transfer wealth from the bottom and the middle to the top (Does Obama really want to imitate Reagan? I hope not.) With the failure (or subversion) of Keynesianism, some other method was necessary to balance supply and demand. The method of choice, for many years now, has been vast amounts of consumer credit—at usurious rates. Those with too much money lend to those with too little purchasing power, and demand is restored. Sort of. Of course, this can only be a short-term solution, since the money must be repaid; demand can be increased by a dollar today only by decreasing it by that same dollar—plus interest—tomorrow. Well, tomorrow has come, and the debt is choking the system.

It is not merely the sub-prime mortgage market, but larger markets that are showing the strains of collapse. The same “securitization” techniques used to spread the risk of mortgage loans has been used in the credit card market. And the bond insurance market, upon which the whole bond market depends, is in similar distress. That's too much sand in the gears of any credit system.

CheneyBush is proposing a “1% solution.” Rebate 1% of the GDP back to the taxpayers (about $150 Billion) to stimulate demand, combined with cuts in interest rates. This will not be a redistribution; they are simply going to print up the money and add to the debt. Further, a lot of the money will go to business tax cuts, cuts which aren't needed, since there is no shortage of capital; the markets are drowning in “liquidity”; that is part and parcel of the problem. Finally, it is only income taxes that are being rebated, while most people at the middle and bottom are taxed mainly through the payroll tax.

A stimulus package based on debt simply won't work any longer. The economy has had seven years of this kind of stimulus, and that string has played itself out, has become part of the problem, not the solution. What will work? The ultimate solution is to restore distributive justice in the wage system (which will involve restoring justice in the property system), but that is a long-term solution. For the short-term, we need an aggressive, even ruthless, redistributive package. Tax the vast concentrations of wealth and income at the top 2 or 3% of taxpayers. The simplest way to do this would be to make the payroll tax progressive and extend to all income levels: slash the taxes at the low end and raise it at the high end. Restore the inheritance tax for the largest estates to discourage the generational accumulation of vast fortunes.

The investor class will scream blue-bloody murder. But this is in their own best interests. What really makes investors happy is having a place to invest at a decent return. But this requires growing markets. You cannot shrink wages and grow markets at the same time. You may engage in some tricks, like consumer credit or printing up money, to finance a market expansion, but this will always lead to collapse. In truth, over the long-term, the investor can only obtain a decent return if the worker also makes a decent wage; there has to be a sharing of rewards, a common purpose, for the economy to balance. And balance is the primary principle not only of economics, but of life itself; those who do not understand this balance can never understand economics, and will likely never understand life.