The elimination of low-risk interest income in favor of risky speculative credit/asset bubbles has led to a monumental misallocation of capital and the institutionalization of perverse and highly corrosive incentives.
The stagnation afflicting advanced economies has several fundamental causes.
1. The dynamic between rising productivity, higher labor costs and technology replacing human labor has shifted decisively in favor of labor-saving technology: the low-risk, high-yield way to increase productivity and profitability is to replace high-cost human labor with software, automation and robots.
This is true whether the labor being replaced costs $10 a day or $100 a day: the machine can produce the output faster, better and cheaper.
This leads to a conclusion that undermines all existing capitalist/socialist models: wages are no longer a practical means of distributing the surplus generated by the economy.
2. Another is the tectonic shift of energy costs: as the cheap, easily accessible oil is depleted, it costs more to extract and refine substitute fuels from unconventional sources. That pushes the cost of energy to consumers higher for structural reasons. The more a household has to spend on energy, the less disposable income is available to spend on other goods and services.
3. The decades-long postwar rise in prosperity naturally led to more demands for government services and income security. These demands are essentially open-ended–there can never be enough money spent on health, education, old age income security, public security, etc.
Since taxes are levied on income, the stagnation of wages means there are limits on how much more income can be diverted to taxes without negatively impacting household disposable income.
The Powers That Be conjured up a solution to these limitations: debt. The central state filled the gap between tax revenues and spending with borrowed money. Companies and households were encouraged to borrow money (i.e. borrow from future income) to spend in the present.
This credit/debt boom was fueled by financialization, a term for the broadening commoditization of debt and debt instruments. Financialization took off in the early 1980s, with the relaxing of restrictions on credit and credit instruments. It was no accident that the stock and real estate markets quickly reached escape velocity as debt filled the coffers of government, corporations and households with cash.
The essence of financialization is turning debt into a tradeable security that can be leveraged into speculative pyramids. If I loan you $100,000 to buy a house, that loan is called a mortgage. The collateral for the mortgage is the property. In the pre-financialization era, I held the mortgage to maturity (30 years) and collected the interest and principal. This trickle of earnings from interest was the entire yield on the loan.
In the securitized economy, I divide the loan into tranches that are sold to investors like stocks and bonds. I can “cash out” my entire gain in the present, and then sell derivatives on the securitized debt as a form of “portfolio insurance” to other buyers.
Clever financiers can pyramid security on security and debt on debt, all collateralized by debt on one property.
This enables the generation of vast profits not from producing goods and services but from financial churning. The more debt I underwrite, the more I can securitize and the more debt instruments I can conjure out of thin air.
The key ontological (inherent) dynamic of speculative financialization is that pyramiding credit expansions lead to bubbles which eventually pop, wiping out the phantom wealth created by the bubble.
In effect, the central state’s (the Treasury, regulatory agencies and the Federal Reserve) policies of low interest rates, easy money and limitless liquidity sought to compensate for the decline of real income by generating speculative income on a vast scale.
The problem is that speculative financialization only benefits speculators with access to nearly free money and the securitization markets–Wall Street financiers, corporate raiders, hedge funds and other financial Elites. These Elites pocketed immense fortunes but very little of this wealth trickled down to households for the simple reason that there is no mechanism for such a transfer except taxes–and this mechanism is controlled by the central state, which is easily influenced by wealth (campaign contributions, lobbying, etc.)
The Federal Reserve and Federal agencies’ solution to stagnating household income was to make every homeowner into a speculator. The Great Housing Bubble of the 2000s was the perfection of this strategy: as every home in the nation was floating higher in valuation as the result of an enormous credit/financialization bubble, homeowners were granted a form of “free income” via home equity lines of credit (HELOCs) and second mortgages.
That this increase in home equity was a form of phantom wealth that would necessarily vanish was not advertised as being an intrinsic feature of the solution.
In the wake of the implosion of the housing bubble, the Fed and other central state agencies acted to repeat the exact same strategy of inflating speculative bubbles in widely held assets: stocks, bonds and real estate.
The problem with these current bubbles is that the assets are no longer widely held enough to compensate for stagnant household income. Few households directly own enough stocks and bonds to push the needle of income higher, and the Fed’s policy of zero interest rates (ZIRP) has actually deprived middle-income households with savings of hundreds of billions of dollars in interest that once flowed into household coffers.
This elimination of low-risk interest income in favor of risky speculative credit/asset bubbles has led to a monumental misallocation of capital and the institutionalization of perverse and highly corrosive incentives. The policy of incentivizing speculation as the mechanism to compensate for stagnating earned income has been a disaster for households and the nation.
Needless to say, the current bubbles in stocks, bonds and real estate will implode, and the phantom wealth that the bubbles temporarily generated will vanish.
Charles Hugh Smith – Of Two Minds