What Keeps the Rich and Powerful up at Night, and Why They’re Happy You Don’t Care

The powerful are pleased we find interest rates boring

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By Tom Streithorst

Imagine Beyonce’s stylist’s hairdresser’s cousin tells you exactly what happened in that elevator between Solange and Jay Z. The story is compelling, explains obscure lyrics in Lemonade, makes intuitive sense. You can’t wait to tell your friends. Everybody chatters excitedly about your news, each adding his or her own analysis and interpretation.  And then, the conversation shifts to something else and neither you nor they ever think about it again.

Knowing which big Hollywood action star has taken steroids for so long he can’t get it up, which gangster rapper prefers trannies, which supermodel passed out at so many parties that a plethora of South London bohemians have copped feels of her unconscious body seems at first glimpse fascinating but is soon forgettable and ultimately useless.

Interest rates are the opposite. After lust, gravity, and whatever it is that holds atoms together, interest rates may well be the most powerful force in the universe. If you knew, for certain, what the rate would be three months or two years or ten years from now you would be rich beyond dreams of avarice. The men and women that rule the planet obsess about interest rates more than just about anything else. They don’t mind the rest of us find them boring.

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So a primer. Knowing how interest rates function will immeasurably improve your understanding of how the world actually works. Bankers and economists spend their life studying this stuff, so to make it comprehensible for civilian readers I’ll have to simplify a bit and leave some things out. Nonetheless, the essence is pretty straightforward. Sadly, economics is one of those subjects where boredom is a signifier of seriousness. That’s to keep the hoi polloi from knowing the secrets inside the temple. I’ll strive to keep this both entertaining and informative. Okay, here goes.

Interest rates are the price of money so changes in rates affect just about everything else in the economy. They connect the present with the future, and remain the most powerful tool policy makers have to control unemployment, inflation and economic growth. The ramifications of interest rate changes can also have vast political effects. Everything from Britain’s victory in the Napoleonic Wars to the success of Reagan and Thatcher can be explained through the prism of interest rates.

By all rights France should have defeated England in the Napoleonic Wars. Its army was bigger, it controlled more territory, its soldiers were better and battle hardened.   Britain’s great advantage: it was credit worthy. Lenders were willing to front capital to Britain much more cheaply than they would to France. Since Napoleon was an absolutist ruler, anyone buying his bonds recognized they could do little should the Emperor decide to stiff them.  Britain, on the other hand, was governed  by Parliament, and investors knew a significant percentage of MPs owned government debt. If Britain refused to pay what it owed, Members of Parliament themselves would take the hit. Parliament would never let the British government default so Britain could access as much capital as needed, allowing it to subsidize allies, build ships, and arm soldiers at a considerably lower cost than the more martial Napoleon. Had Napoleon been able to borrow as cheaply as Britain, he probably would have never had to fight the battle of Waterloo.

Closer to our own time, the Reagan Thatcher revolution that still defines our era would have never triumphed without central bank manipulation of interest rates. Today their neoliberal victory seems inevitable but at the time no one would have imagined the rampant job insecurity and stagnant wages we now accept as an ordinary feature of life. Back then, thermonuclear war or socialist revolution looked more likely than low pay, impotent   unions, and apartments in Manhattan’s Lower East Side selling for over $1 million. Interest rates help explain all three phenomena.

The 1970s have a bad reputation amongst pundits and conservative economists but for most people, they were pretty good. Workers generally got a raise every year. Just about everyone lived better than their parents and expected their kids would do better than they did. With jobs plentiful and secure, getting fired was no big deal. Real wages rose faster in the 1970s than any decade since.

The rich, on the other hand, didn’t do so well. The stock market lost ¾ of its value between 1966 and 1982 and bonds did even worse. Perhaps most terrifying for the elite, ordinary citizens’ respect for established authority dissipated, as the rebellions of the 1960s seeped into the mainstream. Wildcat strikes broke out with increasing regularity, employees refusing to be pushed around by either bosses or union leaders. Workers ruled the shop floor. Management (and owners) feared they had lost control.

Something had to be done. In 1979, in order to stem inflation, Federal Reserve Chairman Paul Volcker raised interest rates. Thatcher did the same in Britain. Both pretended these rate hikes were mere technical measures, tools required to reduce the money supply, but what they were really doing was manufacturing a recession.

Between the Great Depression and the Dot Com bust, almost no British or American recessions occurred organically; just about all were created by the Federal Reserve or the Bank of England. Central bankers call it “taking away the punch bowl just when the party is getting good.” If the economy seemed to be overheating, inflation was threatening or the currency was collapsing, central banks would raise rates and slow the economy.

This is how it works:

When central banks raise interest rates, borrowing becomes more expensive so firms contemplating building new factories are less likely to do so. Investment shrinks. The national economy is composed of consumption, investment, and government spending. Consumption is reasonably constant. No matter what, we need to feed and clothe and house ourselves. Investment on the hand is volatile and variable. With investment declining due to higher rates, the economy contracts. A fall in GDP means that firms are selling fewer goods and when firms are selling less, they layoff workers. Unemployed workers consume less and the economy shrinks some more. Higher interest rates inevitably create a feedback loop that slows the economy.

And that is precisely what happened in the early 1980s. The prime interest rate rose to over 21%, investment collapsed, so did GDP, and unemployment rose to record levels. Volcker’s rate hikes pushed the global economy into the worst recession since the 1930s. Bankruptcies skyrocketed. Businessmen, union leaders, and government officials pleaded with Volcker and Thatcher for a rate cut. Thatcher famously told critics “The lady was not for turning.” The Fed Chairman was implacable in his conviction that defeating inflation was worth the cost in higher unemployment, shattered lives and lost growth.

They succeeded beyond their wildest dreams. Workers fearful of losing their jobs no longer demanded cost of living increases and by 1983, inflation was eradicated, never to return. Combined with anti labour union legislation, it was the  high interest rates and the recession they engendered that crushed workers’ intransigence. Power shifted back to management. Labour’s share of national income declined. A working class hero is no longer something to be. The world we live in today, with few raises and even less job security originated with the rate hikes of the early 1980s.

So the first lesson about interest rates is: higher rates → less investment spending → lower GDP → increased unemployment → lower inflation. Lower rates do the opposite: stimulate the economy and so potentially spark inflation. And right there you pretty much know enough to become a central banker. If you fear inflation and are willing to accept higher unemployment, raise interest rates. On the other hand, if the economy is stagnant and inflation not a threat (the situation we find ourselves in today) then cut rates to stimulate the economy and create jobs.

The effect of Volcker’s decision in the early 1980s had another long-term consequence. Higher interest rates made the dollar (and sterling) more expensive, pricing US and UK manufactures out of global export markets. By raising export prices and reducing investment in modern machinery, the interest rate hikes contributed in transforming America and Britain’s industrial heartlands into rust belts.

That’s because the second major effect of Interest rate hikes is to strengthen the currency. If investors get a better rate in US dollar accounts than in Japanese yen, they will sell yen and buy dollars, lowering the value of the yen and increasing the value of the dollar. A high US interest rate means a stronger dollar, helping American tourists enjoy cheap vacations abroad but hurting exporters hoping to sell goods and service to foreigners. A cheaper yen helps Japanese exporters, a stronger dollar makes US exports more expensive and harder to sell. Manufacturing jobs in the West would have probably disappeared anyway but the Volcker/Thatcher rate hikes certainly sped up their demise. German manufacturing export success is at least partly due to the weak euro.

Most people interested in interest rates, however, are not focused on what they would view as ancient history. The business sections of newspapers obsess about interest rates because knowing their future path is a guaranteed way to make money. Traders think of little else. That’s because interest rates affect the price of just about everything   from gold to shares to bonds to houses.

Which brings us to the next thing to know about interest rates: an interest rate cut will increase the value almost all assets. A rate hike, on the other hand knocks down the price of everything from houses to bonds to shares. Whenever an entrepreneur   previously lauded in the press for his sagacity loses his fortune, it generally isn’t momentary idiocy that eviscerated his empire. The most likely cause of his collapse is an unexpected interest rate hike. Falling rates make aggressive businessmen rich, rising rates bankrupt them.

The great stock market and real estate boom of 1982 to 2007 was fuelled mostly by interest rates falling from 20% to almost nothing. Market participants knew that central bankers had their back, that the Federal Reserve and the Bank of England wanted stocks and bonds and houses to keep appreciating and had the tools to ensure their continued rise. In the 1990s traders called it the Greenspan Put. Any time the stock market sputtered and threatened to decline, Alan Greenspan would cut rates and wiz bang, the market returned to its upward path.

Its easy to understand why house prices go up when rates go down: homebuyers decide how much they can afford by looking at their monthly nut and mortgage costs naturally fall along with interest rates. What is a bit more complicated is why companies and stocks are inevitably worth more. The effect is mathematical, almost magical. The simple explanation is that since interest rates are the cost of money, if money is cheaper then everything else becomes more expensive.

Below a more complete explanation. It isn’t that complicated, really, but if the phrase “discounted present value” or “current value of future predicted cash flows” terrifies you, you can skip the next two paragraphs. If you do skip them, then please just remember this: cuts in interest rates make shares, bonds, firms and homes (actually just about all assets) more expensive. Just 267 words, you can do it!

The value of any asset whether an apartment block or a steel mill or a T Bill or a piece of machinery is the value of the cash flows that asset will generate, from now until the end of time. If a corporate raider wants to buy a company or a firm wants to build a factory, the key question is how much money will it make back compared to its cost. If it makes more money in the future than it costs today, then  spend the money now and buy it. But there is one caveat.

Money in your pocket today is more valuable than a promise of money in 10 years time. You would rather have a dollar now than a dollar sometime in the future. So to find the current value of an asset you have to “discount” its future cash flow to find its “present value”. And the “discount” is the interest rate. Look at it this way. If you have $100 today and you can put it in the bank at 5% interest then next year you would have $105. So $105 next year is equivalent to $100 right now. If rates go up to 10%, an investment would have to make you $110 next year to be worth $100 today. So to determine the   value of any   asset, investment bankers first estimate its future cash flow and then discount it to determine present value. The effect of interest rate changes on present value is quite dramatic. That is why the stock market shoots up whenever the central bank promises to cut rates.

Now I’m going to get a tad metaphysical. Interest rates define the relationship between the present and the future. If interest rates are high, then we “discount” the future more heavily. That is to say, if interest rates are high, money next year is worth much less than money today. Conversely, when rates are low, money in a year’ s time is almost as valuable as money is right now. When rates are high, we live for the moment. When they are low, the future matters more.

So that’s pretty much it. High interest rates slow the economy, lower inflation, strengthen the currency, cut asset prices. Rate cuts do the opposite. I’ve included a handy dandy table at the back of this article, which you can print, laminate and keep in your wallet. Bankers, traders and the people who run the planet know this stuff in their sleep.

But wait. If you have been paying any attention to the global economy since the financial crisis, you’ve noticed a tragic flaw in my argument. I’ve been banging on about how interest rate cuts stimulate the economy and yet, for the past eight years we have had the lowest interest rates since Babylonian times and the economy still staggers along disappointingly. Low rates are supposed to goose inflation but right now, even with rates barely above zero, central banks can’t even manage to hit a 2% inflation target. Today, deflation is a bigger threat than inflation. What is going on? Have I been talking trash? No, we just live in interesting times. For close to twenty years we have been in the midst of what former Fed Chairman Ben Bernanke calls “a global savings glut” and Larry Summers calls “secular stagnation”.

Interest rates, remember, are the price of money, and the price of money (like everything else) is determined by supply and demand. Yes the central banks set a benchmark short-term rate but all other interest rates are mostly fixed by the interaction between the supply of savings and the demand for borrowing. When firms are desperate for funds to build factories and expand their productive capacity, banks can increase the rate they charge. When savers are in short supply, bank will have to increase the rate they pay in order to tempt depositors. Neither is the case today. Rates are low (and will probably continue to be low) because the global supply of savings is huge and the demand for investment isn’t.

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The fundamental function of interest rates is to match our collective desire to save and our collective desire to invest. High rates encourage saving, low rates encourage investing. You are more likely to buy or renovate a house when borrowing costs are low. When rates are high, you will instead be tempted to buy a bond or put money in the bank. The “natural” rate of interest is the one that balances the needs of savers and investors and makes desired savings and desired investment equal.

Today, bizarrely, this “natural” rate is less than zero. The desires of savers and investors are so out of whack that even interest rates barely above zero are not enough to bring them into line. Firms, which normally borrow money to finance expansion, are instead   sitting on mountains of cash. Before the financial crisis, increased mortgage lending took up some of the slack created by business’ insipid investment needs. Today neither firms nor households are borrowing enough to stimulate economic growth.

This unprecedented imbalance between savers and investors forces interest rates down. On the demand side, business borrowing is sluggish because capital goods, the machines and tools and factories needed to produce other products, keep getting cheaper. We all know it takes fewer workers than previously required to produce the same quantity   of goods. What is just as true (if not as obvious) is that it takes less capital as well.

I can see it in my own business of television production. It used to cost hundreds of thousands of dollars to buy cameras and lights and editing equipment good enough to produce a professional quality motion picture. Today you can shoot a movie on your iPhone and cut it on your laptop and still have your film lauded at Sundance. J. P. Morgan needed billions to build US Steel. Mark Zuckerberg founded Facebook with a rented house and a few servers. Everything from steel mills to start-ups requires less capital than ever before. Firms can create more goods and services with fewer and cheaper capital goods, reducing the demand for investment.

Meanwhile, on the supply side, increased inequality means more money goes in the pocket of rich people and rich people save more and spend less of their income. Poor people have to spend everything they get just to get by. The rich, on the other hand can put money away for a rainy day. We save, mostly, because we fear the future and want to make sure that we can continue to consume even if our income declines. Today, professional insecurity is rampant, even amongst the affluent. Few of us are confident we will be able to hold onto our jobs as long as we want. So as soon as we meet our current consumption needs, we try to put some money aside, so we can continue to eat and pay rent should we lose our jobs.

Technological advances allow us to produce goods more cheaply, while economic insecurity frightens us into saving more and spending less. The desire to save increases even as the need for investment decreases. These two trends are not likely to reverse. These microscopic interest rates are not an anomaly: they are likely to continue as far as the eye can see. This creates an unprecedented problem for policy makers. If you can’t cut interest rates below zero, how can you stimulate the economy?

Until the financial crisis, economists were convinced they knew how to end recessions. They had so much confidence in the power of monetary policy they thought they could cure any economic slowdown merely by cutting rates. The past eight years of low rates but little growth have shaken that certainty.

The government has two tools with which to influence the economy: monetary policy, the control of interest rates, and fiscal policy, government tax and spending. For most of the past thirty years monetary policy was thought so powerful that fiscal was almost unnecessary. But now monetary policy has reached its limit. The Bank of England knows it. The Federal Reserve knows it. So do most reputable economists. Monetary policy is maxed out. It is time to try something else.

Interest rates are low today because collectively we have more money than ways to spend it. The private sector craves safe assets, risk free places to put its money. It wants to save. It doesn’t want to borrow.  That means that government can access capital remarkably cheaply, allowing it to invest in infrastructure and education at little expense. Low interest rates are markets way of telling governments to borrow and spend. Austerity has been the wrong medicine, bleeding a patient that needed a transfusion.

So I’ve spun this tale banging on about the importance of interest rates only to end up saying that today, maybe for the first time ever, they are not as effective as they used to be. (Actually, that is not true. Raise interest rates now and watch the global economy collapse.) Interest rates once were the most powerful way to stimulate growth. At zero, they are that no longer. Now, plunging into unprecedented low levels, they have morphed from a tool into an alarm, telling us our economy is broken.

Secular stagnation, a term invented in the 1930s and brought back into fashion by Larry Summers a few years ago, is caused by a reluctance by the private sector to invest as much as the economy requires. If the private sector won’t invest, then the public sector must. In times of secular stagnation, the government should become “the investor of last resort”. We still need investment, in infrastructure, in education, in basic research, even if the private sector is too fearful to fund it.

Only once we recognise what is wrong with the economy can we start to fix it. The cure is right before our eyes. Keynes knew it, Hansen knew it, Kalecki knew it 80 years ago. Increased government spending can bring the economy back to full employment. The microscopic interest rates of the past decade tell us it is time for stimulative fiscal policy.

The powerful are pleased we find interest rates boring. It lets them make money and it means we don’t get in their way. Much better we obsess about Johnny Depp’s finger and Amber Heard’s charitable contributions than we understand the mechanism at the heart of political economy.

2016 September 3

Screen Shot 2016-09-03 at 9.40.56 PM

In summary, an interest rate cut will: raise GDP, stimulate investment, reduce savings, lower unemployment, stimulate inflation, weaken the currency, and make shares, bonds, and houses more valuable.

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  • Sue

    It’s taking me years to get a basic grip on economics because it’s so complicated, convoluted, and yes, boring as batshit. And knowing it is a mug’s game at its heart makes it even harder.

    Where does the idea of a no-growth economy fit into all of this? If degradation of our earth continues because of capitalism’s cancerous need for continual growth, is it,not imperative that an economy that is also cancerous must be changed? How is that even possible? Is the only way for that to happen an economy that doesn’t charge interest? What would such an economy look like (apart from much saner and with less opportunity for the super greedy to erule the roost)?

    • Duncan Cairncross

      Hi Sue
      The problem is not “growth” but increased use of limited resources
      We can have growth without increasing our use of resources by using them smarter

      We can already see that in things like electrical power – California has increased it’s GDP by something like an extra 53% using about 9% more energy

      We need to move to the next stage – reduce our use of limited resources while still improving our quality of life

      • Sue

        I agree that the depth of our use of resources is criminal. I’m excited about the area of biomimicry, where the way we develop things is inspired from the elegant and sustsinable ways nature invents, produces, etc.

        I guess I’ve just always wondered why our methods of introducing and making money require continued expansion to keep the whole system going. It seems a very inefficient way of sharing energy, which is ultimately what money is about – a method of energy exchange. Clunky.

    • RMGH

      I actually think that the biggest problem is not whether we could make it work. We have known for years what we have to do. You can create growth industries from conservation. People will have jobs building the new infrastructure required. Implementation has been the issue. The political climate is the problem.

      The elite have to give ground and not only aren’t they doing it, they are digging in even more. They’ve taken everything that isn’t nailed down and now they’re going after what IS nailed down. I don’t like being a pessimist, but the corruption and rot within our system is so extensive, that I (personally) don’t see a way clear through the electoral process. The only way to get any kind of a life back for the 99% is probably going to involve pitchforks and torches.

      Aside from the fact that I am not a violent person, this puts us in a precarious position. Revolutions are notorious for having very unpredictable outcomes. Even if the 99% went to the mattresses, what we would get after the dust settled could be far worse. But if things don’t change – and soon – massive civil unrest is going to be part of our everyday lives. In fact, its already started.

      • Tom Streithorst

        There is an interesting book called Twilight of the Elites which asks how come the more “meritocratic” we become, the more disfunctional our elites. The author answers 1. that of course we are not really meritocratic, that the rich are able to pass on their privilege but 2. the elites think they “deserve” all they get and so don’t feel like have to share with anyone else and worst of all 3. that even people at the top feel their position is precarious, that with one misstep they could fall from the top .01% to the top 1% or from the top 1% to the top 10% and since those drops have become huge, the elite spends all of its time protecting its own position instead of feeling any responsibility for the society at large.

        I agree with you, revolutions are messy and could easily make things worse. If the elite had any sense, they would notice the dissatisfaction manifest in the Brexit vote and the support for that failed property developer/reality TV star and see that they had better start sharing the benefits. I hope they do. If they don’t we may all pay the price. That would be tragic as the solution to our problems is reasonably straightforward: Universal Basic Income or increased public investment in infrastructure, leading to full employment and rising wages.

        • RMGH

          Thank you for the reply. I read Twilight of the Elites and the ongoing “struggle” to maintain a certain position is part of the problem. But there is also a mindset that is very disturbing. I would gauge it as near sociopathic. The “I’ve got mine,so f$#! you!” mentality becomes ludicrous in light of the fact that most of those in the very top tier could never be depleted into poverty even if the went on a 1000 year spending spree.

          As for pitchforks and torches, I prefer my revolutions to happing with the stroke of a pen. But the behavior of the elites is making this more and more unlikely. I’m in my 50s…probably a bit too old to be parading around with a pitchfork and risking arrest for civil disobedience, but we are reaching a tipping point where desperate people will opt for desperate measures.

          I agree that Trump is the perfect example. Although I deplore Trump’s race baiting, my feeling is that for many, it is economic desperation that is driving his popularity more than bigotry. I reject the message and the messenger, but I feel the fear of his supporters. Their fear for their future is the same as mine.

          Further, I’m concerned that the corruption is so universal and deep. It reaches right down to the most local levels of government. At that point, it often is too late for an ink on paper solution. Unfortunately, that feeling is very prevalent in my own small city where big money is winning over regular constituents every day.

        • John C

          Don’t we need to accept as a society that the true costs of labour reproduction (and by this I mean all social services: health care, education, child care, even pension entitlements really) are not covered by wages in the competitive labour market? It is all well and good for businesses to treat labour as a cost. But we also have to view labour as an asset, which requires investment. If the market takes a narrow view of the value of labour, this will degrade it (ie the population). It seems to me quite facile to say we are no longer going to need labour because things will be automated, because this immediately discounts the infinite capacity for invention that this asset possesses. I for one am not happy with the idea that only a decreasing minority will retain the resources to adequately reproduce themselves, due to asset inflation (and r>g, etc.). It seems to me that you don’t have to be a Marxist to see this conceptual hole which the mumbo-jumbo of general equilibrium theory has done much to obscure. For as long as the rich can say with a straight face that they deserve every penny of their hard-earned rents, income distribution will remain askew and either almost all of us will become debt slaves or the economy will run out of demand. It is also a bit of a gender issue, I might add, because labour reproduction costs have for so long been labelled as “women’s work” and thereby made invisible, or at least excluded from what Edmund Phelps would call the productive economy.

  • George McKee

    Sorry, this article’s “little” model is broken in much the same way that everyone else’s model was broken in 2008. If low interest rates are so wonderful, then with our current near-zero rates, everything should be going great. Japan, Switzerland, and perhaps others that I haven’t noticed even have negative interest rates — their GDP’s should be zooming up off the charts. But their economies are still stagnating.

    Perhaps there are other, more important factors. Everyone has their favorite theory why this is so and what the other factors are; I happen to favor complexity barriers, the ongoing demise of fossil fuels, and the collapse of middle class growth rather than an unfavorable dynamical attractor (an economist would call it one of “multiple equilibria”) that we can kick-start our way out of. The hard problem is how to tell who’s right.

    • Duncan Cairncross

      Try actually reading the article – the author tells you what is happening in the second half

    • Japan and the western nations: industrial base eroding, innovation too slow, population growth too small, resp. negative, so limited expected demand for products?

    • Hannes Radke

      Like the author says: Its uncharted territory.

      The political elite is flying blind, it seems. What I find most curious is how we can clearly see that the western economies are clearly in a comparable position as Japan is for 30 years now. Even more curious is, how neither Japan, nor the western societies seem to be fundamentally incapable of advancing from their current situation. It looks like a trap with invisible walls to them, so there must be some fundamental problem either with all their economic models, or with a political establishment that doesn’t want (or dare) to make a decisive step forward.

      Maybe Steve Keen is right and it’s all about privat debt. Interest rates are a nexus for all sorts of variables, a central cogwheel in the machine.

  • ari9999

    The Napoleonic thing is a cute theory, but I believe acutely lacking in substance.

    If creditworthiness determines who wins and loses wars, then please explain how the modern era’s most creditworthy nation — the one, in fact, that literally sets the global standard — has lost a succession of trillion-dollar wars.

    Vietnam, Iraq, Afghanistan — for starters.

    • Duncan Cairncross

      I agree about the Napoleonic war – Mahan explains why Napoleon lost

      • ari9999

        While I love history, the more pertinent issue is not what happened 200 years ago but what has been happening in our lifetime — perpetrated by our government and a complicit people.

        • Duncan Cairncross

          I agree – and this article does cover what was done to us
          and a tiny bit about how to fix it
          He mentions government infrastructure boost
          IMHO we have got beyond that and we need “helicopter money” or even better a UBI

    • Mike Bryant

      I’ve recently retired from fighting in Bosnia, Albania, Africa, Iraq and Afghanistan. We aren’t supposed to “win” anything. We jockey for position and control within the global resources sector and publicly fund the gigantic military/corporate/political machine. War and fear are extremely good for the Central Bankers.

      • ari9999

        Brings to mind the famous words of Maj. Gen. Smedley Butler, USMC, reflecting on his career in a 1933 speech:

        “I spent most of my time being a high class muscle-man for Big Business, for Wall Street and for the Bankers. In short, I was a racketeer, a gangster for capitalism.”

        Butler was the most highly decorated Marine of his era. This longer excerpt is well worth reading:

      • John M Legge

        Britain was financially strong because it was industrially strong. No amount of money could have allowed the Grand Armee to have survived the disastrous retreat from Moscow in 1812, taught Spanish and French landlubbers how to sail battleships in 1805, or protected the French occupation in Spain from the combination of Spanish guerillas and Wellington’s disciplined and well equipped army. Napoleon lost because his actions created a coalition of enemies far stronger than France. More recently the Allies won WWII because Germany was caught between the dogged defence of the Russians and the overwhelming industrial strength of the USA. As in the Napoleonic wars, American financial strength reflected its industrial strength.

        • Tom Streithorst

          Britain was financially strong long before it industrialized. Had Britain not been able to fund his enemies, Napoleon probably would not have had to invade Russia.

          • John M Legge

            I don’t think that you have this right, but it isn’t very relevant to the post so I won’t take it further.

    • Tom Streithorst

      Actually, Ari, I’ve written several article on that very question: why the world’s largest military can’t win even relatively small wars. The short answer is that America goes to war, mostly for symbolic rather than practical reasons and that is not a recipe for victory. For the longer answer, read either of these:

  • Mike Bryant

    Tom hinted at a major driver of these “interesting times”. Buckminster Fuller called it “ephemeralization”- the ability to accomplish more and more with less. With today’s pace of information flow, technological changes in automation, AI, energy market changes… corporate investments are as volatile as ever- with new software and engineering marvels supplanting entire industries all the time. We are within a very tiny window of time before technology strips human labor completely from the pool and we would do well to heed Tom’s advice- updating and revamping public infrastructure in one last push before technological unemployment and massive deflation crushes society. That enormous flow of money into the working class will soften the inevitable freight train. Unless a UBI arrives to offset that deflation, the guys on Wall Street and in Washington will start to find torches and pitchforks waiting in their driveways.

    • Tom Streithorst

      I think you are really right. We can make more stuff with less labour and less capital. That means as consumers, we live like Gods but as workers, our lives become ever more precarious. Capitalism and technology have largely solved the problem of supply. Our only Achilles heel is demand and UBI probably is the only way to solve that. It is counterintutive but we need to work less and spend more.

      On another subject, I noticed you said you have spent time in Iraq and Afghanistan, as have I. You might be interested in these two articles on why the world’s biggest military keeps losing wars:

      I’d be interested in your perspective.

      • Mike Bryant

        Modern strategic warfare is a gorilla on a skinny tightrope, Tom. I think global transparency is the main driver of military ineffectiveness, but to say that we’re “losing” them is a stretch. Since the advent of the world wide web, War is more “social engineering” that strategic positioning. I would argue that our democracy is staged and that the mainstream news media are denigrated to the role of selling cheap ideological insurance. First and foremost, modern Warfare is key to the creation of national debt… which is justifiably siphoned out of the taxpayers to repay the IMF and central banks with interest. Secondly, the military-corporate-political complex is global in scope and extremely powerful- the longer they can manufacture or buy justification for occupations, the longer they can justify the overpriced manufacturing of beans, bullets, band aids and fuel. Winning wars is bad for business and (in their eyes) bad for the economy. Finally, in order to “win” a modern war, you have to aggressively eradicate the enemy’s core ideologies and nationalism in an age of instantaneous global telecommunications and feedback loops… Only education and freedom can do that. Those aren’t profitable at all.

  • Where would be GDP if we had, say, 5% interest rates? Declining?

  • TedKidd

    A Universal Basic Income will remove the impediment of fear.

  • I find this to be an excellent journalistic exposition of Keynesian analysis of the secular stagnation we face today. I particularly like the summary: “Only once we recognise what is wrong with the economy can we start to fix it. The cure is right before our eyes. Keynes knew it, Hansen knew it, Kalecki knew it 80 years ago. Increased government spending can bring the economy back to full employment. The microscopic interest rates of the past decade tell us it is time for stimulative fiscal policy.”

    What I like most about this article, however, is that it clearly highlights the differences between Keynesian economics and the economics of Keynes. It is highly misleading to include Keynes in the summary of those who recognized what is wrong with the economy in terms of being caused by savers and investors forcing the rate of interest to zero (though it is quite understandable for a journalist reporting on Keynesian economics to do this since Keynesian economists supposedly speak for Keynes) when Keynes argued throughout the GT that the rate of interest is NOT determined by saving and investment. And it just plain false (though, again, understandable) to suggest that Keynes believed we could solve the problem of secular stagnation—which Robertson dubbed “the long-period problem of saving”—simply by bringing the economy back to full employment through stimulative fiscal policy.

    What Keynes actually concluded with regard to the long-period problem of saving was: “I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment . …” [GT, Ch. 24, Sec. III]

    It seem fairly clear to me that the fallacy in the Keynesian analysis of this problem, which is concisely explained in this article, is that there is no accounting for what happens to deficits and debt when full employment is reached through fiscal stimulus. Keynesians seem to think debt can just pile up forever when full employment is reached and there is no reason to worry about this. I don’t think so, and even though Keynes never addressed this problem directly, his conclusion with regard for the need for “a somewhat comprehensive socialisation of investment” and his discussion of the negative effects of a high concentration of income does not suggest that Keynes believed a continually increase in debt relative to income would not be a problem.

    It is my understanding of the problem we face today that the policies supported by mainstream economists over the past fifty years have transformed the economic system in such a way that, given the resulting current account deficits and increase in the concentration of income at the top, the mass markets for consumption goods in the United States have been undermined to the point that the economic system can no longer achieve potential output and full employment of our resources in the absence of a continual increase in debt relative to income. It is the unsustainability of a continual increase in private-sector debt relative to income that eventually led to the Crash of 2008. And given the existing distribution of income and the state of mass-production technology it is the inability to either a) continually reduce the trade deficit, b) continually increase debt relative to income through dissaving at the bottom of the income distribution, c) continually increase debt relative to income in the public sector, or d) continually create speculative bubbles to stimulate investment that has led to the diminished long-term expectation with regard to consumption that is the primal cause of the economic stagnation we have experienced since 2007.

    I have posted a number of papers on my website, , that explain why I believe attempting to maintain full employment through continually increasing debt (whether private, public, or foreign) relative to income is unsustainable in the long run: explains how mainstream policies led to an increase in the concentration of income and economic instability. explains the way in which these policies led to a trade deficit and the deleterious effects that have resulted. explains the consequences of the increase in the concentration of income and trade deficit in creating a situation in which full employment can only be maintained through a continual increase in debt relative to income. summarizes the argument and suggests the kinds of policies that are needed to deal with this problem if we are to survive this situation with our fundamental economic, political, and social institutions intact. explains why mainstream economists, both Keynesian and anti-Keynesian alike, have failed to grasp the nature of this fundamental problem which Keynes explained in excruciating detail in the GT.

    I would deeply appreciate any comments the readers of Evonomics might have on any of these papers.

    • Mike Bryant

      Capitalism has been phenomenal, George, but it has one flaw. There is no law that requires people to be part of the production process. The volatility of consumer purchasing power is directly tied to sufficient employment and companies are needing fewer people to make the system work. Technological unemployment, debt, institutional mistrust… Profit at the expense of trust. Our government has one last chance to jerk our economy into line through massive investment in public infrastructure, education and research. It will only change the timeline, but will soften the impact before massive technological unemployment forces the UBI. Afterward, it’s anyone’s guess what our monetary system will transform into. Post scarcity economics, resource-based economics, blockchained social currency, the end of money? Fascinating times.

      • Technological progress (being able to produce more with less/increasing productivity) is obviously a good thing and is something that has been going on for a long time. It doesn’t necessarily mean unemployment, at least not in the long run. In essence, what I argue in and is that there are two ways in which full employment can be maintained as productivity (technological progress) increases.

        The first is to allow the increased income made possible through productivity increases to accumulate at the top of the income distribution thereby increasing the concentration of income. When this is the case full employment can only be achieved through a transfer of income from the top to the bottom through an increase in debt relative to income. This is unsustainable in the long run as it inevitably leads to financial crises, economic depressions, civil disorder and/or political repression. ) This is the kind of situation we experienced throughout the nineteenth century leading up to the Crash of 1929 that led us into the Great Depression. We experienced six major financial crises and depressions (1819, 1837, 1857, 1873, 1893, and 1907) during this period each of which (save 1907) seemed to be worse than the one that came before. It is also the kind of situation we experienced leading up to the Crash of 2008 and the Great Recession we are in the midst of today.

        The second is to allow the increase in income made possible through productivity increases to facilitate a fall in the concentration of income thereby increasing the standard of living throughout the population. This is the kind of situation we faced following WW II leading up to the 1980s. During this period full employment was fairly well achieved without a significant increase in debt relative to income, and there were no major financial crises or economic depressions. Even in this situation, however, eventually we must face Keynes’ long-period problem of saving which I examine in .

        • Mike Ekoniak

          George – your profile pic looked familiar enough that I looked up your bio on your website, and discovered that you were at GMI for a time. I attended from 1999-2003; any chance you were there at the time?

          • Mike, I only taught a few classes at GMI for the School of Management back in the late 1980s so chances are we didn’t cross paths at GMI.

  • ornerycuss

    Thanks for this. I’m sure there are plenty of know it alls btl who will shoot it down but for a student like me this is great.

  • Jay

    I like your article. It must be one of the most plain-speaking and easy to understand one for layman out there. Thanks for writing it!

    I have a question:

    How does anyone know if government spending/investment will result in a non-negative real return on investment? Don’t get me wrong, I’m all for more government spending, even if it only results in greater redistribution. I’m just curious how anyone can know for a fact that government investment will be effective in lifting real economic growth?

    • Tom Streithorst

      If govt spend an extra $1, then GDP immediately goes up $1. Extra spending, whether private or public automatically raises GDP. Now because of the Keynesian multiplier, that $1 of spending will increase GDP even more than $1. A worker gets paid more, say cuz of a govt infrastructure program, so he can spend more. Extra govt spending raises GDP more than just the increased govt spending because of the multiplier.

      Back during the Great Depression, Keynes said the economy had a “magneto” problems (magneto is what they called starters back in the 1930s). We had the productive capacity to produce what we needed but demand was insufficient. Increased govt spending puts money in workers pockets, which they spend, which gives the private sector reason to hire and invest, which creates feedback loop which gets he economy out of recession. It is the multiplier created by increased govt spending which creates that feedback loop.

      Now conservative economists have argued since the 1970s against fiscal policy, saying that increased govt spending “crowds out” private sector investment. In other words, build a library or a school, then the private sector can’t build a factory. Personally, I think this has always been bullshit (the economy is not a zero sum game) but even if it could be true sometimes, miniscule interest rates tell us it is not true now. The private sector doesn’t want to invest so increased govt spending will not crowd out potential private sector investment. Indeed, by increasing demand, it will stimulate investment.

      We all can see places where we need public investment: better schools, repair infrastructure, etc. The big lie since the financial crisis has been: we can’t afford it. But of course we can. Increased govt spending, especially on infrastructure, education and basic research, will create jobs today and a better future tomorrow.

      • Jay

        Thanks for the explanation on the multiplier effect and how it was used to pull the economy out of the magneto problems. I can agree with everything you’ve said here.

        It seems to me, though, the fact that the US public debt as a percentage of GDP has been on an upward trajectory, it signals that government taking on more debt for public initiatives and spending – the way it’s been done since the 80s in the US – has diminishing effect on increasing real economic growth. Indeed, if you look at public debt to GDP ratio it has been trending upwards since the 80s, while real economic growth has been trending downwards. I think there’s at least a modicum of truth that govt spending has increasingly been ineffective (wasteful?). What do you think?

        The issue of a lack of demand keeping a lid on nominal GDP growth and employment is real and the Keynesian prescription seems to be right way forward. However, it really does seem to me that without accompanying reforms that deal with inefficiencies and rigidities in the US economy, the Keynesian prescription will only, so to speak, “kick the can down the road”. Empirically speaking, one should not pin too much hope in the Keynesian prescription for dealing with the lack of real growth.

    • gary bridges

      I agree and the table at the end is also very easy to understand.

  • Jim Hale

    This is excellent information. However, I find the answer at the heart of the article. The economy is broken because of the obscene accumulation of wealth in the hands of a few. The governments of the world could stimulate and invest in infrastructure, but the wealthy must put their money into the government first. Tax system restructure??

  • Dick Burkhart

    If zero interest rates won’t work, why not negative interest rates? That is, you pay someone to borrow and invest your money. Government could do this. But even this begs the question that is never asked in this article: What does our economy actually need so that (1) all people have the basics, (2) it’s egalitarian and equitable, and (3) it’s sustainable?

    The private economy does not and cannot adequately address any of these issues. Instead if people with lots of money can’t find productive investments they just use it to bid up the price of assets,.This increases the extravagant lifestyles of major owners of assets but does nothing to address the real needs of our economy. It’s way past time for the people, through government, to regain control of banking and investment.

  • Bob Walker

    There are so many amazing Trends aligning right now… Tech+Social = Mass change. Uber, AirBnB are only the beginning. This is the decade of the “Sharing Revolution”.

    This is also where many new Jobs will come from. Corporations hate employees. They are an “expense” in old school businesses. But in this new Economy It aligns perfectly. Betting against the Millenials, keeping them economically disadvantage helps no one.

    This is not a Tech revolution, its a “Process” revolution.

    Don’t think Uber, and AirBnB are rare events… This next decade belongs not to tech, but to “Process”. In the coming few years, networks of people will collaborate and compete with large Corporate business models. (Like a Hostile Takeover!)

    I’m an Engineer, who spent my career in software development. Business systems, B2B, lots of custom Apps for publishing, inventory, order processing. Always saving companies ooodles of money.

    Thats why I can state with some confidence, by adding collaborating “software” to enable new networks of people, Millenials can seriously upset many big companies today.
    Uber, AirBnb are just the beginning .. Join me.

    I call it the “Process” revolution.

  • Vigneron
  • Chris Mack

    Great article. Shockingly terrible conclusion. “hey guys, just increase government spending”. My god. All that time on analyzing the problem, none on the solution.