This month, The Financial Times has been running a series of articles entitled Capitalism In Crisis, written by a number of the world’s most renowned economists and policymakers. That series reveals just how far we are from resolving the enormous crisis confronting us – not because of the insights contained in the articles, but because the entire premise of the series is completely wrong. This is not a crisis of Capitalism.
Capitalism was an economic system in which the private sector drove production through a process of capital accumulation and investment; and in which the government played a very limited role. The United States has not had that kind of economic system for decades. Today, the federal government spends $25 out of every $100 spent in the economy and the central bank creates the money and manipulates its value. Moreover, the economic dynamic is no longer driven by capital accumulation and investment as it once was.
Instead, credit creation and consumption have become the dominant forces propelling economic expansion. This is not Capitalism. It is something completely new. That even The Financial Times (perhaps the world’s best newspaper) does not yet understand this fact is deeply disturbing.
Capitalism was a 19th Century phenomenon. It did not survive World War I. That war destroyed the classical gold standard upon which Capitalism had been built, and it forced the governments of the belligerent nations to take near-total control over economic production.
The unprecedented expansion of government debt required to fund the war created the credit bubble now known as the Roaring Twenties; and the boom of the 1920s caused the Great Depression of the 1930s when the credit that fueled the boom could not be repaid. World War II resulted in complete government control over the economy once again. During the decades that followed, government spending on social welfare programs surged and military expenditures accelerated. By the 1960s, the government employed both Keynesian and Monetary tools to control the rate of economic growth. Finally, in 1968, Congress removed the legal requirement that dollars be backed by gold. That change allowed an explosion of fiat money-denominated credit creation that completely transformed our world.
Total credit in the United States first topped $1 trillion in 1964. Over the following 43 years, it expanded 50 times to $50 trillion. That credit created unprecedented wealth, profits, jobs and tax revenues. It ushered in the age of Globalization. So long as credit expanded, prosperity increased. Credit replaced Capital as the key economic driver.
The economic system that went into crisis in 2008 had little in common with Capitalism. Creditism is a more appropriate name for it because it generated economic growth through a process of credit creation.
Why then is Creditism in Crisis? It is in crisis because credit, unlike capital, has to be repaid. Now, a great deal of the $50 trillion of credit that fuelled the prosperity of the last four decades cannot be repaid. Moreover, much of the private sector is no longer creditworthy, making further credit expansion impossible. Therefore this credit-driven economic paradigm appears incapable of generating any new growth.
That is not all. Over the past 40 years the proliferation of credit has wrought enormous changes on the structure of the global economy. The United States has been deindustrialized as the result of its ability to buy goods from low wage countries on credit. As Industry contracted, Finance grew to be the dominant sector of the economy. Now that Americans can bear no additional debt, Finance too has become a sunset industry. Deindustrialized and heavily in debt, the United States can no longer act as the driver of global economic growth. Consequently, not only is the U.S. economy no longer viable as it is currently structured, neither are the economies of all the countries, such as China, that have grown by pursuing a strategy of export led growth. None of these global imbalances have yet been corrected.
The reality is that to a very large extent, the government now manages the United States’ economy – and U.S. demand remains the most important factor generating economic growth throughout the rest of the world. The actions taken by other governments and government-related institutions must also be carefully monitored. For instance, the December announcement by the European Central Bank (ECB) that it would lend Euros 489 billion (approximately $630 billion) to European banks for up to three years at low interest rates is THE reason that global stock markets have rebound over the past six weeks.
By chance, two months ago, at the peak of the “Euro Crisis,” I was in Europe making a presentation to institutional investors in Geneva, Milan, Frankfurt, Edinburgh and London. The mood there was very grim. Last week, I made the same presentation to investors in New York, Kansas City, Chicago, San Francisco, L.A. and Austin. The change in sentiment was astonishing. Although the long-term prospects for the global economy remain very disturbing, the ECB’s intervention has staved off what many had feared would be a near term global economic breakdown originating out of a banking crisis in Europe. Global markets rebound sharply not only because of the success of that intervention itself, but also because of the growing realization that there would be more government-directed interventions as and when necessary to prevent other crises in the future.
While it is truly regrettable that the global economy now depends on government intervention to prevent economic collapse, given the sick state of the global economy, government intervention is far preferable to the horrors that would accompany such a breakdown.
“Market forces” still play an important role in the economy, but now, more often than not, government action has so much influence on market forces that it becomes unclear where the government influence stops and the market begins. Supply and Demand are still the ultimate arbitrators of value, but today, governments often have an extraordinary influence on both. It is crucial for investors, policymakers and the voting public to recognize this - and to understand that this is not Capitalism. At this stage, there is no point trying to fix the “crisis in Capitalism.” We must fix the crisis in the current economic system within which the global economy now operates. Administering the “right” cure to the wrong patient could prove fatal.
What do you think? Is it a crisis of Capitalism or is it a crisis of Creditism? Please provide your comments below. And for more information, click here to see our financial education resources.