I offer to give you practice. I ask that you contemplate and take seriously an impossible thing: That capital is not magical. It is subject to the same laws of supply and demand and pressure to rationalize as any other commodity. The reason the return of capital is low is that there is simply too much of it. As novel as an idea that may sound, I assure you I did not make it up. Rather, I suggest to you there is a subtext to the financial and economic history to which you are well acquainted that once understood this, the success of capitalism, to be its own major challenge.
Also, rest assured this is not a rehashing of former Treasury Secretary Summer’s attempt to resurrect the secular stagnation hypothesis. Summers thinks he just recently discovered the fact that the pool of saving exceeds the demand required for modern business. His solution go-to-solution is a large-scale public investment project.
The American economist, Harold Vatter, argued more than forty years ago that since the 1920s, net new investment was in decline. The net, Vatter was discussing was investment excluding depreciation. The kind of technological progress that we experienced was not only labor-saving but capital saving as well. Not as much capital was needed in the production of goods and services as had been the case. What Summers sees as a special case, Vatter had identified it as a general case under modern capitalism.
The surplus capital is the key political-economic challenge was recognized by American intellectuals and policymakers at the start of the 20th century. They saw domestic outlets for the congestion and envisioned a consumer-oriented society and culture, creating new needs and desires, as well as a substantial social safety net—anticipating both Keynes and the New Deal.
They understood this was not sufficient, and looked for foreign outlets as well. This was not simply an expansion of the rentier class of portfolio investors, content to clip coupons. Rather what was envisioned by direct investment, building infrastructure in other parts of the world and developing a market for US goods and services. This is a vision of non-imperialist expansion.
The imperialist powers of the 19th century carved the world into spheres of influence. A rising power of the time, the US, did not accept the inherited world order. In the Open Door Notes, the US argued for a new global architecture that replaced the fixed spheres of interest with variable shares. The variability would depend on one’s economic prowess. The fixed spheres were products of rent-seeking behavior, currying favor with a political ruler to get economic concessions. The new irreverend power’s variable share rewarded profit-seeking behavior.
Besides the unfathomable loss of lives, World War I and II destroyed the surplus of capital. Anticipating a return to pre-war economic conditions, the Open Door Notes were globalized in the form of the World Bank, International Monetary Fund and GATT (the predecessor of the World Trade Organization). However, as the surplus capital rebuilt, strains on the system were evident nearly a decade before the eventual collapse of Bretton Woods in 46 years ago last month.
The surplus savings was penned up by regulations and capital controls. The offshore dollar market had already begun when the Soviet Union took their deposits out of US banks and brought that to British merchant banks. Capital waged a two-front battle. It enlisted the state to weaken organized labor. Through regulatory capture, it freed itself from the regulatory shackles.
What we associate with Reagan and Thatcher was in effect turning the 20th-century Open Door strategy on its head. The surplus capital problem was on a global scale, and the US is exporting capital only exacerbated the challenge. Instead, what Reagan-Thatcher was a new strategy to deal with the surplus. The US, and to a less extent, the UK, Canada, and Australia, would absorb the world’s surplus savings and production. This is to say the US (and a few other smaller countries) would run substantial current account deficits and capital account surpluses.
The Great Financial Crisis marks the end of the Reagan-Thatcher strategy to deal with the surplus capital, the formidable challenge to capitalism that has been lost by in the changing political narrative and an approach to economics which is infatuated with esoteric mathematical proofs. When the conservative US President Nixon severed the last link between the dollar and gold and instituted wage and price controls, little did we have an inkling of the world Reagan and Thatcher were going to usher in a decade later.
Similarly, a new strategy to deal with the surplus capital, not within our grasp. In the meantime, officials are trying to come up with other ways to absorb the surplus, including changes in the regulatory environment. In some ways, it might be helpful to think about QE itself as an attempt to deal with the surplus capital.
When farmers have a bountiful crop, and the price threatens to fall below the cost of production, governments often invent schemes to buy the crop and warehouse it and let it agricultural produce come to market when at a better (i.e., lucrative) time. In some ways, QE can be understood as a similar strategy: Warehouse the surplus capital. This is not a permanent solution. There is a political push back on the grounds that it blurs monetary and fiscal policy. There is an ideological resistance to the “interference” with market forces. There are economic arguments against the distortion of prices and the mutation of printing signals.
Interest rates are low, not simply because central banks are buying bonds and maintaining large balance sheets by recycling maturing issues. Interest rates are low because there is too much capital. It is a recurring source of the crisis in market economies. We should anticipate that returns to capital will remain low until a new strategy to deal with the surplus is devised and accepted, and the risk is that we are still in denial.
Opinions expressed are solely of the author’s, based on current market conditions, and are subject to change without notice. These opinions are not intended to predict or guarantee the future performance of any currencies or markets. This material is for informational purposes only and should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision. Further, this communication should not be deemed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency. There are risks associated with foreign currency investing, including but not limited to the use of leverage, which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors, depending on their financial sophistication and investment objectives. You should seek the services of an appropriate professional in connection with such matters. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed.
Recommended Content
Editors’ Picks
AUD/USD holds above 0.6500 in thin trading
The Australian Dollar managed to recover ground against its American rival after AUD/USD fell to 0.6484. The upbeat tone of Wall Street underpinned the Aussie despite broad US Dollar strength and tepid Australian data.
EUR/USD comfortable below 1.0800 lower lows at sight
The EUR/USD pair lost ground on Thursday and settled near a fresh March low of 1.0774. Strong US data and hawkish Fed speakers comments lead the way ahead of the release of the US PCE Price Index on Friday.
Gold pulls away from daily highs, holds above $2,200
Gold retreats from daily highs but holds comfortably above $2,200 in the American session on Thursday. The benchmark 10-year US Treasury bond yield stays near 4.2% after upbeat US data and makes it difficult for XAU/USD to gather further bullish momentum.
Google starts indexing Bitcoin addresses
Bitcoin address data is live on Google search results after users realized on Thursday that the tech giant started indexing Bitcoin blockchain data. However, mixed reactions have followed the tech giant's reversed stance on the cryptocurrency.
A Hollywood ending for fourth quarter GDP
The latest revisions put Q4 GDP at 3.4%, the second fastest quarterly growth rate in two years. Much of the upside was attributable to stronger consumer spending, yet fresh profits data affirmed it was a good quarter for the bottom line as well with profits up by the most since the Q2-2022.