WASHINGTON – In a well crafted WSJ op-piece (The World-Wide Undermining of Free Markets, August 11, 2015), financial adviser Romain Hatchuel points out some worrisome truths. Western policy-makers, monetary authorities in the lead, have pursued policies that have undermined the foundations of capitalism.
Years of ZIRP
This is what central bankers have done. Many years of zero per cent interest rates, (ZIRP, for Zero Interest Rate Policy), plus massive asset purchases and quantitative easing have created a dangerous new environment. As a result of easy money, the price of many assets has been inflated. Current high stock market valuations are false, in as much as they are largely the outcome of stimulative policies that made cheap money available to investors, while traditional savings vehicles are out, because of the prolonged zero per cent interest policies pursued by all major central banks.
China manipulates markets
At one extreme, you have China. Obviously China is not a capitalist market economy. But, according to its apologists and many admirers it is well on its way to become one. Really?
Most recently the Chinese authorities prevented a stock market meltdown by suspending trades, distributing essentially free cash to stock brokers so that they would buy shares and forcing share holders to hold on to their stocks. All this, of course, with the noble objective of preventing major losses for millions of improvident investors.
Still, be that as it may, all of the above indicates that China does not have –and has no immediate plans to create– real capital markets in which buyers and sellers freely determine share prices. It is all manipulated.
Inflated stock prices
But what about the rest of the world? We used to have real capital markets. Well, we do not have Chinese extremes, but we are getting there. Fed mandated ZIRP has created a bubble. So much so that every time a credible rumor of any type of Federal Reserve rate hike comes out, investors reflexively sell stocks.
Why is that?
Very simple. Because most of them know that they are holding stock portfolios whose value is artificially inflated by the Fed’s zero per cent interest policy that has been kept in place for 6 years, that is well after the end of the 2008 Financial Crisis. Therefore, it makes sense to believe that if and when rates go back to normal stock prices will go down because the artificial incentives to buy expensive stocks will vanish.
So, Wall Street may be not the Shanghai Stock Market, but in both of them transactions are heavily affected by non market factors that support or inflate share prices.
At a different level, what about large and growing fiscal imbalances? It is amazing to notice that by and large there is almost total indifference vis-a-vis large fiscal deficits that over time caused the additional growth of an already immense national debt in Japan, Europe and the US.
Large fiscal deficits are largely caused by unsustainable entitlement programs designed in a different era, with different cost structures and different demographic trends.
To put it simply, these programs now cost too much. But instead of dealing squarely with the issues and devising sensible ways to reform the programs, this way making them sustainable, elected leaders prefer to side step the politically thorny decision to reduce benefits. They decided to finance the same, essentially unchanged, programs through more and more debt.
Japan is leading the way. This once energetic economy now has a national debt equal to 240% of GDP. This is astonishing. What this means is that, even with a Japanese version of ZIRP currently in place, almost half the country’s total revenue has to be devoted to debt service. This means that Japan has to divert scarce capital from investments to paying interest on this monumental debt.
And yet, all seems normal in Tokyo. Nobody talks about this absurd level of debt as an emergency that requires drastic action.
Issue ignored in Washington
Well, move to Washington and, while the numbers are less frightening, we have the same complacency. It is implicitly understood by almost all candidates for national office, (we have a presidential campaign underway), that even talking about entitlement reform is political suicide.
Social Security, Medicare and Medicaid (these are the big entitlements) are essentially untouchable. And this is folly. The costs of these entitlements will inevitably go up. The baby boomers are retiring. The active population that pays into the system is shrinking. This is like watching a train wreck in slow motion. We know exactly what is going to happen.
Much more can be said about the damage caused to business creation by heavy corporate taxes and absurd regulations. Taken altogether, the outcome of the policy mix is highly toxic. We have fake money that causes inflated asset prices. Unstoppable entitlement spending that is destroying public finances, and excessive regulations that are choking enterprise.
Here is my conclusion. Markets are hardly perfect. Capitalism is a messy and often wasteful system. The 2008 Great Recession is illustrative of what can happen when investments turn into crazy speculation, while people keep buying over inflated assets (and fake securitized mortgages) with the certainty that prices will never go down.
Yes, 2008 and its aftermath was a horrible show of human folly. And yet the cure may be even worse. Public policy has created a new false semi-prosperity, in the context of sluggish economic growth. Asset prices are once again inflated. Millions of people keep get unaffordable benefits financed through soon to be unsustainable debt.
And politicians keep offering more free goodies. There is a little bit for every one. Higher minimum wage. A policy that in practice amounts to debt forgiveness for student loans. More categories of workers entitled to over time compensation. More food stamps for low-income people. And subsidized heath services for millions through Obamacare. In all this, the Democrats propose redistributive tax measures so that more wealth will be transferred to the poor and to the lower middle class.
Drifting away from capitalism
I fully concur with what Hatchuel wrote in his WSJ op-ed piece about America slowly drifting away from its capitalistic roots. Indeed, current policies largely focused on support and subsidies, while they ignore the need to promote economic growth, have slowly eroded the fundamentals of free market capitalism.
The way it used to be
It used to be the case that you would get ahead in America mostly because you were part of the productive, money-making sectors of the economy. You got rich because you produced wealth, and not because you were part of a protected class.
As I said, the capitalistic system is most imperfect. It is prone to excess and speculative frenzy, while even seasoned players make gigantic errors. But I have yet to see a better alternative.
The idea that savvy policy-makers can successfully manage markets, and grow the economy, so that we can all prosper within a fine-tuned system is a complete absurdity. Many failed experiments –from Fascism to Communism to Social-Democracy– amply demonstrate this assertion.