Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
Display:
Interfluidity: The negative unnatural rate of interest (November 8th, 2011)
I think this aberrationist view is quite wrong. I don't think you can make sense of the last decade without understanding that the so-called real interest rate has been trying to fall through zero for years. Only tireless innovation by the men and women of Wall Street prevented negative rates long before the traumas of 2008. A deep cause of the financial crisis was a simple expectation: That lenders ought to earn a "decent" real, risk-free yield even while a variety of trends -- skyrocketing incomes for the 0.1%, the professionalization of investing, leverage-induced risk aversion, China -- were creating Ben Bernanke's famous savings glut. The market response to a global savings glut ought to have been sharply negative real interest rates for low risk savers. But as a society, we resent and resist that capitalist outcome. It is well and good for markets to drive the price of undifferentiated labor asymptotically towards zero. But God forbid that "savers" not be paid for supplying a factor that turns out not to be scarce. Instead, an alphabet soup of financial innovations was conjured to transform bad lending into demand for low risk money, and thereby support its price. Now those innovations have failed, and the fact of negative real interest rates is plainly before us. But we are still, desperately, resisting it.

...

Ideally, a special class of borrowers, entrepreneurs, would invest borrowed funds in projects precisely designed to meet savers' future consumption requirements. But in a sufficiently unequal society, the marginal saver may have vastly more wealth than is necessary to endow her own future consumption (including proximate bequests). There may be lots of ways to turn today's resources into "future wealth" in a general sense, but goods and services in excess of what today's lenders will be able to consume or reinvest in future periods are worthless to the people who set the price of money. The marginal productivity of investment may remain high technologically even as its marginal productivity to existing lenders turns sharply negative. (More accurately, both the marginal present and future dollar may have no consumption value to a lender, but in a accounting terms the value of a present dollar is fixed, while the relative value of a future dollar is flexible as long as there is inflation or some other means of circumventing the nominal zero bound.) It is the marginal productivity of investment to existing lenders that sets a floor beneath market interest rates. If we posit satiable consumption and sufficient inequality, market interest rates can approach -100% even while technologically fruitful projects go unfunded, because the projects would be of benefit only to people with little to offer the marginal lender.

...

Our current negative real interest rates are not an aberration, but a product of longstanding and continuing trends. However, since neither those trends nor the negative rates are conducive a decent and prosperous society, it is foolish to refer to them as "natural". We need to alter the circumstances under which full-employment requires that lenders pay borrowers to spend. We need to reshape "nature" until the new natural rate is positive. We need to understand the circumstances that lead investors to accept negative real returns rather than finance new ventures. We have to think about issues like income and wealth inequality, the structure of labor markets, institutional investor incentives, financial risk-aversion and deleveraging. We need to transform existing institutions, or invent new ones.

(my emphasis)

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Nov 18th, 2013 at 06:01:09 AM EST
This critique of the view that secular stagnation is unnatural brings to mind J.A. Hobson's work http://www.marxists.org/archive/hobson/1902/imperialism/, 1902, wherein he described Imperialism as being necessary to capitalism as the capitalists paid their workers too little to consume what their factories could produce and didn't want to pay them more. The solution was to sell their output into captive markets in the Empire and to invest in rent producing enterprises in the Empire, such as railroads in India. In the US Henry Ford instinctively took the other view. I say instinctive because of the demonstrated vast ignorance of the world beyond auto manufacturing that Ford unwillingly provided under cross-examination in court.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Nov 18th, 2013 at 08:36:45 PM EST
[ Parent ]
That's an excellent piece.

I've noted in the past that we've been entering an equilibrium (I say entering because it is at different stages around the world) where there are large pockets of people with needs, but no money - and small pockets of people with money, but no particularly unserved needs.

Economic analysis as operated by many economists breaks down at that point. SRW points to how you can analyse it... but in the end it becomes a political rather than economic problem...

I think it's also really important because it points out how ideologically loaded the notion of "secular stagnation" really is. Conflating technological productivity with "lending productivity" allows lenders to claim a high ground that doesn't belong to them.

It's interesting to me that Clayton Christensen, looking at all this "secular stagnation" stuff from the bottom up (he's a professor studying innovation) has come to very similar conclusions, although he sees it as money trapped in a cycle of financialisation that starves "real economy" innovations of investment...

by Metatone (metatone [a|t] gmail (dot) com) on Tue Nov 19th, 2013 at 06:53:04 AM EST
[ Parent ]
There are no transcripts of the talk I was at. Here's some small tidbits from another event he spoke at:

Clay Christensen warns CIOs that smart managers are doomed to fail

There is more than one way to disrupt the market. In addition to disruptive market-creating innovations, which succeed by offering products or services to a class of customer that previously didn't exist, there are sustaining innovations. These succeed by replacing good products with better ones (Prius for a Camry). Efficiency innovations, on the other hand, succeed by offering the same product at a lower price (Geico). Each plays a different role in the economy. Market-creating innovation requires capital and creates jobs. Sustaining innovation is "replacetive" in nature and, while making the economy more vibrant, does not generate a lot of jobs. Efficiency innovation eliminates jobs but frees up capital for other things. It's kind of a neat system, Christensen noted.

"As long as the market-creating innovations are creating more jobs than the efficiency innovations are taking out," he said, "and as long as the efficiency innovations are creating enough capital to fund the market-creating innovations, it is like a perpetual motion machine."

But since the 1990s, this nifty machine -- the envy of the global economy -- has been under assault from the "Church of New Finance," his name for the doctrine taught at places like the Harvard Business School, he said, that measure profitability by how efficiently a company uses capital. What the new ratios offer is two ways to achieve good results. Return on Net Assets (RONA) comes out just fine by either increasing the numerator or decreasing the denominator. "Either way RONA goes up," Christensen said. The same holds true for internal rate of return, the ratio that basically expresses how quickly one can get money out of an investment. Innovation is hard. Since those market-creating innovations that generate jobs often take five to 10 years to pay off, wouldn't it make more sense to invest mostly in efficiency innovations?

The end result of pursuing that strategy, however, is that profits accumulate but job growth declines. "That is why we are not getting out of the recession and why we are not creating jobs," Christensen said. And the doctrine makes no sense, he added, giving the audience a glimpse of the passion bordering on rage that fuels his pursuits. A scarce commodity when these measures took hold, capital is abundant today. The cost of capital is zero. America is awash in cash. Instead of hoarding capital, companies should be pouring it into innovations that create jobs. And yet, the management tenets of the Church of New Finance -- which protect capital at all costs -- "make it impossible for smart people to do what needs to be done to sustain growth in the industry," he said.

by Metatone (metatone [a|t] gmail (dot) com) on Tue Nov 19th, 2013 at 06:58:30 AM EST
[ Parent ]
(He doesn't have the political awareness to make the connections that many here will make, but I think it's interesting to see someone articulating how SRW's thoughts are playing out in terms of money flows and institutions...)
by Metatone (metatone [a|t] gmail (dot) com) on Tue Nov 19th, 2013 at 06:59:29 AM EST
[ Parent ]
I've noted in the past that we've been entering an equilibrium (I say entering because it is at different stages around the world) where there are large pockets of people with needs, but no money - and small pockets of people with money, but no particularly unserved needs.

Economic analysis as operated by many economists breaks down at that point. SRW points to how you can analyse it... but in the end it becomes a political rather than economic problem...

Of course it is, and of course you can, and of course it does. But Keynes already analysed that 80 years ago:
There is, however, a second, much more fundamental inference from our argument which has a bearing on the future of inequalities of wealth; namely, our theory of the rate of interest. The justification for a moderately high rate of interest has been found hitherto in the necessity of providing a sufficient inducement to save. But we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest, provided that we do not attempt to stimulate it in this way beyond the point which corresponds to full employment. Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment.
(my emphasis)
There can be no doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto; and, so far as one can guess at the schedules of the marginal efficiency of capital corresponding to increasing amounts of capital, the rate of interest is likely to fall steadily, if it should be practicable to maintain conditions of more or less continuous full employment unless, indeed, there is an excessive change in the aggregate propensity to consume (including the State).

I feel sure that the demand for capital is strictly limited in the sense that it would not be difficult to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure. This would not mean that the use of capital instruments would cost almost nothing, but only that the return from them would have to cover little more than their exhaustion by wastage and obsolescence together with some margin to cover risk and the exercise of skill and judgment. In short, the aggregate return from durable goods in the course of their life would, as in the case of short-lived goods, just cover their labour costs of production plus an allowance for risk and the costs of skill and supervision.

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.

Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward.

At the same time we must recognise that only experience can show how far the common will, embodied in the policy of the State, ought to be directed to increasing and supplementing the inducement to invest; and how far it is safe to stimulate the average propensity to consume, without foregoing our aim of depriving capital of its scarcity-value within one or two generations. It may turn out that the propensity to consume will be so easily strengthened by the effects of a falling rate of interest, that full employment can be reached with a rate of accumulation little greater than at present. In this event a scheme for the higher taxation of large incomes and inheritances might be open to the objection that it would lead to full employment with a rate of accumulation which was reduced considerably below the current level. I must not be supposed to deny the possibility, or even the probability, of this outcome. For in such matters it is rash to predict how the average man will react to a changed environment. If, however, it should prove easy to secure an approximation to full employment with a rate of accumulation not much greater than at present, an outstanding problem will at least have been solved. And it would remain for separate decision on what scale and by what means it is right and reasonable to call on the living generation to restrict their consumption, so as to establish in course of time, a state of full investment for their successors.

(The General Theory, Ch. 24, section II)

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Nov 19th, 2013 at 07:02:26 AM EST
[ Parent ]
We have to think about issues like income and wealth inequality, the structure of labor markets, institutional investor incentives, financial risk-aversion and deleveraging. We need to transform existing institutions, or invent new ones. -SRW (MY bold)

A good place to start transforming existing institutions might be pension funds. They play a key role in financial systems as they receive steady inflows of money today to cover obligations due in decades while paying out money today for obligations arising from money received decades ago. If they are not agencies of a country sovereign in its own currency then they can only pay out what they have received plus what they have earned on prior surplus receipts. Following inception they have a significant period in which inflows significantly exceed outflows. This serves as a source of capital for investment.

In the '60s the New York State Pension Fund invested in Green Valley, a retirement community south of Tuson and at a somewhat higher elevation. This was an excellent investment as it produced an asset that could service the needs of retirees and in a milder climate with lower land and construction costs. But, with continuing financialization of the economy pension fund 'investments' became more problematic. Even state backed funds 'invested' in the oil commodity boom that broke in July '08 and, in the new reality of Zero Interest Rate Policies, they are having difficulty even keeping up with inflation. This is one of the major downsides to ZIRPs and the losses are likely to be absorbed by a combination of the pensioners and the taxpayers of states that guarantee these retirement funds.

I can see only two real possibilities. Either the federal government assumes responsibility for shortfalls or we adopt sane macroeconomic policies. Some combination of both policies may offer the best result. I think this situation is symptomatic of an economy in which the financial sector has become many times the size of the underlying real economy. When that happens it is hard to keep the majority of the profits generated in the society out of the hands of financial sector executives and shareholders and it is even harder to keep them from controlling the government and using that control to their benefit and to the detriment of the general population. So the first step should be to cut the financial sector down to no more than twice the size of the real economy and keep it there.      


"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Nov 21st, 2013 at 10:10:17 AM EST
[ Parent ]

Display:

Occasional Series