Lax lending standards, cheap credit, and massive central bank liquidity injections have created a toxic level of financial flexibility in the US economy. As financial conditions move further and further away from the real economy, comparing the United States to the losing countries of the Cold War doesn’t seem like an exaggeration.
MEDFORD, MASSACHUSETTS – Comparing the capitalist economies of today to the communist bloc of yesteryear may seem far-fetched. What could the free market have in common with Soviet-style central planning? In fact, the comparison offers more and more useful information about what has become of the winning side since the end of the Cold War.
Consider the “moderate budgetary constraints” enjoyed by socialist state enterprises (SOEs), which turned out to be one of the main reasons for the failure of the economies of the Soviet bloc. Similar financial conditions are becoming ubiquitous in capitalist America.
Like the Hungarian Marxist apostate János Kornai argued, SOEs could ignore losses and consumer preferences, because they could always count on the state to keep them afloat. Kornai’s thesis was popular with Chinese reformers of the 1980s: Seeking to make SOEs more market responsive, they “tightened” corporate budget constraints. In contrast, capitalist America seems to be on the same ill-generated path as the Soviet economies. Although it starts from a different location, the result is the same. Budget constraints are loosening and capital is increasingly funneled into fashionable and well-connected fantasies and schemers.
Of course, borrowing can, to a certain extent, energize capitalist enterprises. Contrary to what one reads in introductory economics textbooks, real-world consumer budgets are not capped, and adventurous consumers can borrow to pay for the next hot new item. By consuming beyond their means, they are driving demand for iPhones and Tesla, creating incentives for innovators.
Likewise, Tesla and other early stage companies often depend on external funding, not profits, to advance their innovations, just as governments issue bonds to help pay for highways, bridges, ports, and airports. Savers also benefit. Instead of putting excess money into mattresses, they can cost-effectively meet the financing needs of consumers, businesses and governments.
But too much financial flexibility can be toxic. While individuals, businesses, and governments can reasonably predict wages, income, and tax revenue for the next month (respectively), they can only guess at their ability to meet their obligations many years from now. The more optimistic the forecast, the greater the willingness to spend beyond your current means or to invest more than your retained earnings.
Subscribe to Project Syndicate
Our new magazine, The coming year 2022: the results, is here. To receive your printed copy, delivered wherever you are in the world, to subscribe to PS for less than $ 9 per month.
Like a PS subscriber, you’ll also get unlimited access to our On Point suite of premium feature length content, Say More contributor interviews, The Big Picture themed collections and the entire PS archive.
In principle, financial due diligence should impose compensatory limits on this overextension. But estimating creditworthiness and investment returns is not an exact science, and competition in the financial industry can lead to a race to the bottom, with borrowers flocking to the more forgiving creditors.
In addition, fractional banking and fiat money can further ease funding constraints. Banks don’t just lend savings to their depositors; they mine these deposits multiple times. And central bankers have even more powerful powers to create funds out of thin air.
While traditional financing constraints have weakened over the past decades, the growth in household and business debt has far outpaced the growth in their income and profits. Likewise, the growth in US government debt – now exceeding $ 29 trillion – is beyond imagination. Yet as borrowing has surged, interest rates have fallen, further encouraging reckless borrowing and lending.
These lax lending standards have apparently spread to the stock markets. Last year, some four million people described themselves “monkeys”Bought billions of dollars in AMC stock, saving the movie chain from bankruptcy. Celebrities now Floating after-sales service (specialized acquisition companies) with a strangely effective pitch: “Give us your money, but we won’t tell you why”. Hedge funds and private equity firms have crowded into venture capital (VC). Valuations have skyrocketed – nearly 340 new companies have raised funds at valuations exceeding $ 1 billion in 2021. And, the type of due diligence that once took months has been reduced to days or even hours with some “spray and pray” VCs.
This combination of manic investments and negligent loans did not emerge spontaneously or is not the result of the complacency that accompanies a long period of stability, as argued Hyman Minsky, the great theorist of financial crises. The dot-com bubble collapse in 2000 and the global financial crisis eight years later should be fresh in the memory of most financiers and investors. The problem, rather, is that central bankers have deliberately instigated indiscriminate lending and “risky” trading on an historically unprecedented scale.
Worse, while central bankers have apparently given up a lot of the proverbial “helicopter money”, funds have not been evenly distributed. Monetary policies were designed to lower credit standards, thereby favoring unwary borrowers. The liquidity provided by the central bank that poured into the stock markets found its way into fashionable “meme” stocks and PSPCs (in addition to the several trillions of dollars from big tech companies). VCs favor well-connected founders with brilliant resumes. Yet as they raise the valuations of the most glamorous companies, they fund less than 0.5% of all American start-ups. A well-known venture capital firm even launched a fund dedicated to the purchase of cryptocurrencies.
Savers too smart to speculate have fallen behind. The same goes for companies that have resisted the temptation of cheap money. Under current conditions, their less cautious competitors may pay more for employees and other scarce resources.
What kind of calculation capitalism faces – or when – is impossible to predict. In the end, Kornai’s Hungary failed slowly, not suddenly. She and other Soviet-style economies that fueled the “investment hunger” of privileged state-owned enterprises kept store shelves empty of goods consumers wanted and less connected producers could have supplied. In the absence of wartime or 1970s-style price controls of the type imposed by President Richard Nixon, such shortages and rationing regimes seem unlikely in the capitalist West. The current inflationary surge could ease further as supply chain bottlenecks ease, as the US Federal Reserve anticipates another financial collapse.
But steadfastly defending the stock markets only prolongs the state-sponsored misallocation of capital. And, sadly, the current generation of central bankers appear to lack the determination that allowed the late Paul Volcker to tighten financial constraints when he ran the Fed four decades ago.