Originally published at www.dailycapitalist.com on September 15,2010
The Power of Capital
The most valuable economic substance in the world is capital. It is not "money" if we define money as pieces of green paper. Governments cannot create wealth by printing money. If they could we wouldn't have to work.
The formation of capital plus a culture of entrepreneurship is the only way to create economic well being. When government policies destroy capital it diminishes everyone's economic well being.
Capital is saved wealth. If you produce goods and you make a profit and save the profit, then you have created capital. Ditto with your labor. If you spend all of your wages, you've saved none of the wealth created from the goods you made and you have no capital.
It takes societies a long time to create and amass capital. In the U.S. we have a dynamic financial infrastructure to generate wealth/capital. It started with the rights guaranteed by the Constitution, but it took about a century to create our wealth-creating financial infrastructure. While you can criticize it all you want, wealth is widely distributed in America when one compares our standard of living to elsewhere.
This financial infrastructure is called capitalism.
Our current economic policies are destroying capital and our well being. These policies are now globalized. They are the Economics of Mass Destruction.
International Coordination of Economic Policy
I have a folder entitled "Supranational" in which I keep research related to international regulation of the world's economy. As I anticipated, after the Crash nations joined together to coordinate economic policies and the regulation of financial activities.
The conformance of economic policies was rather automatic. Most of the world's economic ministers, especially those of the G-20 countries, have adopted familiar Neo- Keynesian/Neoclassical policies of fiscal and monetary stimulus. In most countries the results of these policies have been as disappointing as ours.
Look at monetary stimulus. It is no coincidence that central bank interest rates of advanced economies are historically low; they all are trying to create massive monetary stimulus to revive their economies. Higher interest rate countries such as the BRICs with less stable economies either have more trouble selling sovereign bonds on the international markets or are attempting to thwart rising prices.
Central Bank Interest Rates
Almost all these countries engaged in fiscal stimulus as well. The Bush Administration committed about $700 billion to the various bailout schemes. Then the Obama Administration came up with a massive Keynesian spending program (initially $787 billion). Other countries followed:
Type of Stimulus as a Percentage of GDP
Note this subsidies chart doesn't reflect the U.S. TARP and related bailouts. Source the OECD
The last piece of the globalization of economic policy was to increase regulation over financial activities. The post-Crash drive to coordinate financial regulation was unified by the theory that the cause of the Crash was Wall Street: the investment banks, investment companies, hedge funds, the big "banksters," and insurance companies. Not to mention greed and overpaid executives. If governments admit any fault it is that they failed to adequately exercise their existing regulatory powers.
Which means that many of the laws passed here are or will be similar to those enacted in other major countries. For example, the Dodd-Frank financial overhaul act contains many rules that had been discussed with G-20 counterparts. "Forum shopping" or the "you can run but you can't hide" policy, was a major factor. The new bank capitalization rules of Basel III are an outcome of the Crash. No treaties are required to accomplish most of this legal conformation; meetings between economics ministers and their regulatory staffs were all that was needed and individual governments did the rest.
The Failure of Regulation
Unfortunately our new laws (Dodd-Frank) fail to address the primary cause of the Crash: the Federal Reserve itself. Its years of easy money policy kicked off the massive credit boom that landed on the housing market because of U.S. government policies that encouraged capital to flow into residential real estate. The boom ended when the Fed raised rates. I don't mean to spare Wall Street in my criticism; they failed in many ways, primarily their faulty risk models. But, while they pushed the scheme forward, they didn't cause the boom or the bust. History shows us that cheap money from central banks, or from banks or sovereigns pre-existing central banks, always have caused these boom-bust cycles. Just because the Fed took over doesn't mean that bad banking theories changed.
The Globalization of Failed Economic Policies
The purpose of this article is not meant to be an exposé of an international conspiracy or secret cabal to control the world. These policies are the logical conclusion of theories of economics and political organization that have been taught in our universities before our oldest citizens were college freshmen. Some of these ideas even trace back to Ancient Rome. Sub sole nihil novi est.* These ideas were developed in Europe, but took root and flowered in our best universities. Because of the stature of America's academic institutions, which stature is founded on capitalism's prosperity, it is no surprise that these Neo-Keynesian ideas have spread throughout the world.
*There is nothing new under the sun.
You may believe this regulatory coordination and conformation is a good thing because it gives enterprise a more stable regulatory foundation in which to operate. Or that it is necessary to prevent another crash. Or that regulators have superior knowledge and can be trusted to properly guide economies. But that is not the case.
The serious economic problems we have are the direct outcome of mainstream economic thought and these ideas now operate worldwide. If one studies economics in London, or Paris, or Rome, or Beijing, the lessons are very much the same. If one examines the policies of the EU and its member states or China or Japan, they are remarkably similar.
Perhaps the term the "Economics of Mass Destruction" is a bit of hyperbole, but I am giving fair warning that we Americans, the most dynamic capitalists and the primary drivers of the world economy, are heading for long-term economic decline if we continue with the same Keynesian doctrine that got us into the current historically big mess.
While it is nice to believe that emerging economies such as Brazil, Russia, India, and China will take up the slack, I am not convinced they yet have in place the cultural and financial resources that have made America the world's leader.
Because of the globalization of these ideas, it now appears that the whole world will rise or fall on these policies.
The Fallout of Economic Conformity
The logical conclusion of these failed policies is economic stagnation. Here is what massive government spending and taxation has done to our economy:
Total government (federal, state, and local) share of the economy has exceeded the tipping point, estimated to be between 15% and 20%, which is the point when it hinders economic growth. Presently total government spending for 2010 is estimated to be about 47% of the economy.
Taxation must rise substantially in order to pay for government debt, health and welfare entitlements, and other fixed government costs. The 2010 estimate of federal, state, and local taxes amount to about 30.4% of GDP (about $4.480 trillion).
Our total government debt (federal, state, and local) is estimated to be $16.635 trillion for 2010, approximately at 114% of our GDP (2010 E$14.623 trillion). Of total government debt, federal debt is estimated to be $13.787 trillion in 2010.
f=federal govt.; s=state govt.; l=local govt.
f=federal govt.; s=state govt.; l=local govt.
The larger the share of governments' take of capital out the economy, the less money there is available for businesses and consumers. The less capital available for the private economy, the less it will expand, and the result will be a decline in GDP.
While progressive utopians believe that taxation of the "rich" is acceptable to fund social benefits, mathematics, demographics, and the laws of economics prove them wrong. Progressives have yet to understand that government produces nothing.
The table, below, shows tax rates of many major economies as a share of their GDP. The welfare states have taxes approaching 50% of their economies, with the median in the high 30th percentile. The U.S.'s tax burden on the economy of 30.4% is less than most of these countries. While we ramp up our welfare state which assures higher taxes, Europe's welfare state services are crumbling and face drastic shortfalls as their GDP falls, as their populations age, and as their companies find better conditions abroad.
The Economics of Mass Destruction
The Organisation For Economic Co-Operation And Development (OECD) is an economic think tank put together by 33 countries of which the U.S. is a member (see above chart for members). Most members are economic powers. China and India are not members. It generates a lot of data, but very little useful research. It is located in Paris and has 2,500 international staff members. They take a rather hard Keynesian line. One need only look at their logo to see where they stand:
The OECD just came out with their Interim Economic Assessment, "Recovery slowing amid increased uncertainty" said the headline. They, like the Obama Administration are realizing that their Keynesian policies are failing.
The world economic recovery may be slowing faster than previously anticipated, according the OECD's latest Interim Economic Assessment. Growth in the Group of Seven countries is expected to be around 1½ per cent on an annualized basis in the second half of 2010 compared with the previous estimate of around 2½ per cent in the OECD's May Economic Outlook.
The OECD says the loss of momentum in the recovery is temporary although uncertainty has increased....
If the slowdown reflects longer-lasting forces bearing down on activity, additional monetary stimulus might be warranted in the form of quantitative easing and commitment to close-to-zero policy interest rates for a long period," the OECD said. "Where public finances permit, planned fiscal consolidation could be delayed. [my emphasis]
It is clear that the OECD does not understand what is happening. Otherwise they wouldn't need to suggest more fiscal and monetary stimulus if they really believed the "loss of momentum in the recovery" was only "temporary."
Its announcement sounds almost as if the Fed had written it. Here's what Chairman Bernanke said on August 27, 2010:
Overall, the incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year....
We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.
The Obama Administration is proposing more government fiscal stimulus spending to boost the economy.
The only thing these policies have achieved is the destruction of capital.
The Fed and other central banks have been printing money to pump liquidity into their economies. These policies aren't working. Credit is declining, money supply is declining, and the creation of fiat money destroys capital by devaluing currencies.
Massive government spending on politically favored projects adds nothing to the economy and destroys more capital. One need only look at U.S. stimulus spending at Recovery.gov to see where the billions are going. If it worked the economy would be growing and unemployment would be declining. The opposite is happening.
How does repairing a highway in Ohio lead to economic growth? The answer is that it won't; once the money is spent, the repair jobs go away and the capital is gone.
Is it possible that the private economy would find better things to do with that capital? We need to ask what the person whose capital was taxed away by the government was going to do with it. I am sure that the answer would be that it would be preserved or used for new economically viable businesses. Only savings, not spending, creates capital for renewed growth by private enterprise.
Eventually governments run out of capital if they dominate their economies long enough. High taxes and a welfare state lead to lower incentives to produce and lower incentives to save. Most of these countries are still spending the capital earned in former, freer market economic times. If they destroy enough capital they will go bankrupt and plunge their economies into serious depressions.
The outcomes of policies that destroy capital will vary from country to country, but none of them will be good. In the U.S. we can look forward to stagflation: years of high unemployment, low productivity, and rising inflation. Japan will continue its 20-years of low productivity and deflation. China will experience capital destructive boom-bust cycles. Germany may be the sanest of all by ignoring the conventional Keynesian wisdom by cutting government spending.
A sobering thought is that these capital destroying policies are being exported to developing countries as well. As these economies emerge from controlled economies to freer systems, they need time to amass capital to drive their growth. Most advanced economies experienced a century or more of rather hands-off capitalism before they turned into welfare states and regulated economies. China cannot morph into a dynamic capitalistic economy by burning up capital of its entrepreneurs through graft, wasteful spending, and harsh regulations.
There is no refuge from the world's plunge into massive capital destruction. At one time in history you could flee to countries with freedom and free markets, such as America. With the globalization of Neo-Keynesian economics, there is no refuge. Watch out for EMDs: the economics of mass destruction is here.