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.

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Usury!

There! I've said it. I know it's not supposed to be said. I know it's an outmoded, even medieval word, a relic of clerical meddling in economic science. And yet, the shamans may be ahead of the scientists on this one.

First, what is usury? It is not, as some suppose, charging interest on a loan. Rather, it is charging interest on a non-productive loan. What does that mean? Well, we can lend money for production or for consumption; we can lend money to start a business (or expand one) or to finance current consumption, such as buying a hamburger (which is now commonly put on plastic.)

When money is lent for a productive enterprise, the lender is entitled to a share of the rewards, since he also shares in the risk. The loan will then be liquidated by the success of the enterprise, or will be written off with the failure of the enterprise. But in either case there will be no additional burdens, hence no “usury,” that is, no “using up” the stock of society.

But if the loan produces nothing, then nothing can be charged for the loan, or else it is a simply wealth transfer rather than real growth. The scholastics also recognized the right to receive compensation for certain “externalities” of money, namely for risk and the loss of the use of the money. But beyond these legitimate claims, usury is simply a transfer of wealth from one class to another that produces nothing of itself: It is wealth without work. This is especially true of consumer loans. They are merely a claim against future earnings without contributing to those earnings. An economy that depends on consumer lending to fuel consumption is in fact merely borrowing from consumption in future periods.

Usury, aside from its character as avarice, as the desire for wealth without work, has troublesome practical consequences as well. On the one hand, it “covers up” problems in the distribution system, that is, with the wage system. If we did not inject massive amounts of consumer credit, there would be a massive failure of demand and the problems of inadequate pay would become apparent to all. As it is, these problems are hidden and will remain so until the ponzi-scheme collapses (as it must), as it does in depressions. On the other hand, usury detracts from the amount of capital available for productive investments; the absurdly high rates of interest make investment in production less attractive than investments in financing consumption.

Perhaps the last well-known economist to take usury seriously was John M. Keynes, who said:

Provisions against usury are amongst the most ancient economic practices of which we have record. The destruction of the inducement to invest by an excessive liquidity preference was the outstanding evil, the prime impediment to the growth of wealth, in the ancient and medieval worlds…I was brought up to believe that the attitude of the Medieval Church to the rate of interest was inherently absurd, and that the subtle discussions aimed at distinguishing the return on money-loans from the return to active investment were merely Jesuitical attempts to find a practical escape from a foolish theory. But I now read these discussions as an honest intellectual effort to keep separate what the classical theory has inextricably confused together... (The General Theory, 351-52)

The standard economic theory treats all interest as just another form of profit. But this is incorrect. Indeed, it would be like calling the funds from a bank robbery profit; in a narrow sense they are, since they represent an excess of income over outflow. But interest and profit serve different ends. It is legitimate to think of interest as profit only when it is a participation in profits; but when it merely finances current consumption, then it is that greatest of social evils, wealth without work, growing rich without adding anything useful to society.

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