A Macro trend that worries me a bit

Published by Anonymous (not verified) on Mon, 12/02/2018 - 11:30pm in


Economics, Piketty


10 Year Treasury Rate - 54 Year Historical Chart; source: Macrotrends.

Let me start with two claims I will not pursue in this post: (i) I am very confident that the price of Bitcoin is a bubble (some other time about that). I honestly don't know (ii) if last week's market correction was the start of a downward trend in stock prices or just a minor hiccup in a long-run bull market. This post is not intended to make anybody money or to predict the future (say, in the manner of Donald MacKenzie who wrote about the Volatility Index just before it rose again).

Since 1980 headline interest rates have been in full decline. (The inflation adjusted curve has the same shape, but is slightly less striking. The early 70s had historically low real interest rates before the great run-up.) In what follows I treat this, for simplicity's sake as a free-standing cause (and abstract away from the political and economics reasons for this decline).* During this long decline, governments could borrow relatively easily, bond-investors grew rich without much effort, bankers could make easy money in virtue of their license to print money, and it was easy to make money in financial and real estate assets (which made retirement planning for upper-middle class families easy). That, together with stagnating wages, has had huge effects on income distribution (see Piketty).

Thirty-seven years is a long time.+ That's longer than the Berlin Wall stood; longer than (ahh) the thirty-years war. That is, expectations have been trained up on falling interest rates; business models and risk models across the economy rely on cheap credit and falling interest rates as an ordinary fact of life. For example, "most deposit models [of big European banks]  are based solely on a period of decreasing interest rates and hence might entail high model risk."  I suspect nobody really knows what the effects on the financial sector and real economy will be once interest rates have really bottomed.

Of course, even if interest rates have bottomed it does not follow they will go up. But I would think that inflation expectations will rise following the combination of tax-cuts, government deficits, discouragement of immigration, and persistent low unemployment.

Few active traders remember what it's like to be in a market in which interest rates go up regularly and systematically. The present financial sector is almost certainly not very robust in such an environment; Just recently the President of the Minnesota FED was adamant that "The biggest banks need more capital, and that’s the best way to protect taxpayers," {HT. Eric Winsberg} Almost certainly European big banks are in worse shape.++ Governments are surely not well prepared to borrow at substantially higher costs. Whatever the economic effects of (hypothetical) rising interest rates will be, they require very tough and politically unpalatable choices by regulators and governments unless we're really are on a higher economic growth trend. (But that's not obvious given aging populations. [Again, if immigration is really curtailed that will worsen matters.])

Now, since the last great recession, neo-Fascist parties and sentiments have been growing in popularity all over the world. Leaving aside, say, Greece (which has suffered greatly economically), this has happened during peacetime, relatively low inflation, and -- despite all the challenges -- relatively prosperous times.** So my worry is, if interest rates rise, and there will be another severe bout of economic dislocation and hardship, will neo-fascism get its lucky break? For my suspicion is that it's precisely when reliable expectations are thwarted that people are willing to be receptive to radical alternatives.

*Undoubtedly, Volcker, the decline of unions, automation/computers, and the astounding  integration of world markets have something to do with all of this.

+Yes, there have been periods when interest rates seemed to move back up a bit.

++Why? Well, the European stress test has been unreliable, and the European banks have not really been recapitalized nor restructured since the Great Recession.

**My assumption being that war and high inflation are the most fertile breeding ground for fascism.

On Spooner and Basic Capital.

Published by Anonymous (not verified) on Mon, 15/01/2018 - 11:47pm in

The inevitable result of these principles would be that the class of employers, who now stand between the capitalist and laborer, and, by means of usury laws, sponge money from the former, and labor from the latter, and put the plunder into their own pockets, would be forced aside; and the capitalist and laborer would come together, face to face, and make such bargains with each other, as that the whole proceeds of their joint capital and labor would be divided between themselves, instead of being bestowed, in part, as now, as a gratuity, upon an intermediate intruder. The capitalist would not only get all he now gets as interest, and the laborer all he now gets as wages, but they would also divide between themselves that sum which now goes into the pockets of the employer. What portion of this latter sum would go to the laborer, and what to the capitalist, would depend upon the circumstances and bargains in each particular case. The probability is that for the first few [36] years after these principles went into operation, capitalists would ask and obtain a pretty high rate of interest. The competition among laborers, in their bids for capital, would produce this effect. But as the general safety of the system should be tested, and as laborers should gradually make accumulations, which would serve as some security for loans, and as the business of banking should be increased, the rate of interest would gradually decline, until—probably within ten or twenty years—capital would go begging for borrowers, and the current rate of interest would probably not exceed three or four per cent. And all the proceeds of labor and capital, over and above this interest, would go into the pockets of the laborer.--Lysander Spooner (1846) Poverty: Its Illegal Causes and Legal Cure, 

In Poverty, Spooner attacks usury laws, promotes free banking, and (as I discussed earlier) insists on complete debt forgiveness after a debt is due and been repaid to one's capacity. Thereby, Spooner hopes to promote a more equal economic regime -- he explicitly has in mind the conditions prevalent in early nineteenth century New England -- in which banks and capitalist employers are reduced in significance and a lot of us are independent economic agents with our own capital. He is a fierce critic of conditions that generate poverty and extreme wealth inequality. He argues that his scheme will generate not just higher average income, but also more equality. He thinks the rich will be less productive than  autonomous, middle class economic agents. He expects independent workers to more productive than wage-earning workers. He seems to think most firms will be limited in size.* Let's call this a Spooner economy.** This is relatively lightly regulated and with firm property rights and few sources of rent-seeking behavior.

Somewhat surprisingly he does not advocate for an estate tax, and this undermines part of the grounds of his egalitarian optimism. That is, Spooner thinks high returns to capital are primarily due to the structure of the banking sector, the bad regulation of credit, and capitalist modes of production. But he seems to miss the possibility that the wealth of the wealthy may grow at a faster rate than the growth in wages of the rest of us due to the growth of the economy (Piketty's famous formula, r > g). It is an open empirical question, if in a Spooner economy, Piketty's formula holds.

Before I return to Piketty, let me note that Spooner is a critic of financial intermediaries which both (a) profit from other people's labor and (b) because of lack of access to capital among the poor, make (i) wage-labor necessary, and thereby (ii) produce an economic hierarchy that sustains a small class of capitalists and a large working class. (As should be clear he is also a critic of forms of credit that create permanent indebtedness among the working poor.) In addition, and this is clear from the quoted passage above, his moral criticism of financial intermediaries is that the relationship between creditor and debtor becomes an impersonal one; it's not 'face to face.'  To adopt Steve Darwall's framework, in a Spooner economy, economic agents relate to each other in the second person. For Spooner production is a joint enterprise among independent and mutually interdependent economic agents with each getting its fair share.+ It is a remarkable vision, especially because it is articulated just as the industrial revolution and the large corporation are taking off full steam.

A natural extension of Spooner's position, while taking unequal initial conditions, or unfair historical legacies, and higher returns to capital seriously, absent significant estate taxes, is a basic capital scheme (as distinct from a basic income scheme). There are many variants on this. Ordinarily basic capital is understood as a  'one-off lump sum of financial capital paid to the individual on maturity' by the state (White 2011). If one  recognizes (i) that the largest investors are better positioned to profit from the cost of discovery (Brown et. al.: 2008) and (ii) that better endowed institutions tend to have higher risk-adjusted returns on their investments (Piketty 2014: 570-1), then ordinary basic capital scheme is not sufficient. One should find a way for the non-rich to grow along with the wealthy.*** In reflecting on a Piketty (without fully endorsing all of Piketty's claims), the influential mathematical economist, Debraj Ray, suggested (recall here) that "all [the world's] inhabitants must ultimately own shares of physical capital." (2014) By 'physical capital' Ray means land and financial assets. That is to say, if we want to make the growth of capital a joint enterprise each of us should (have a) share in its growth.



*It's unclear if recognizes that there may be barriers to entry in capital intensive industries; he also seems rather diffident about potential economies of scale.

**It's very similar to a Smithian economy, but Adam Smith is more friendly toward worker regulation and progressive taxes, including estate taxes.

+Some other time I will return to the benefits of impersonal mutual cooperation.

***Again, it's not clear if these empirical relations hold in a Spooner economy.

Thursday, 11 February 2016 - 1:39pm

Published by Matthew Davidson on Thu, 11/02/2016 - 1:39pm in

I'm reluctant to contribute to the Piketty backlash, as it seems to me to be mostly motivated by the unrealistic expectation that his book should have provided a comprehensive theory of everything. However this blog post from Alexander Douglas provides such a pithy account of the workings of public fiscal balances that it's worth recirculating. In response to the claim that "there are two main ways for a government to finance its expenses: taxes and debt," he writes:

Government spending isn’t financed by anything. The government pays for everything by crediting the non-government sector (employees, companies, foreign governments, etc.) with financial claims. Some of these claims are returned to the government in order to settle liabilities to the government (for instance in tax payments); others remain as financial holdings for the non-government sector. At any given moment the claims remaining as financial holdings constitute the whole of the ‘public debt’.

Tax revenue largely depends on the volume of spending. Decisions to spend rather than save are largely at the discretion of non-government agents. It is therefore very misleading to speak, as Piketty does, as if the government chooses to ‘finance its spending’ through taxation or debt. The amount of government spending that remains as ‘debt’ is largely up to the discretion of non-government agents choosing whether to hold onto financial claims or pass them on so that they can eventually find their way back to the government.

It therefore makes no sense to panic about government "budget" deficits, if you're not also going to bemoan private savings. Ironically, as it happens, private savings currently is a big problem, as corporations hand out mattress stuffing — in the form of dividends and share buybacks — rather than investing. Yet more ironically, the appropriate response is for the government to make up the investment shortfall through large fiscal deficits. Otherwise the economic stagnation rolls on until (sorry, I can't resist it) r>g.