Later On

A blog written for those whose interests more or less match mine.

How Monopolies Broke the Federal Reserve

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Another excellent column by Matt Stoller in BIG:

Former Fed Chair Janet Yellen, just before the 2016 election, gave an important speech about how economists don’t really know much about how finance and the economy intersect. Here’s what she said.

Extreme economic events have often challenged existing views of how the economy works and exposed shortcomings in the collective knowledge of economists. To give two well-known examples, both the Great Depression and the stagflation of the 1970s motivated new ways of thinking about economic phenomena. More recently, the financial crisis and its aftermath might well prove to be a similar sort of turning point.

Her thesis is that the crisis revealed an intellectual gap at the heart of economic thinking. Yellen was correct in her observation. And there’s a signal that the blind central banking establishment has failed to to maintain any semblance of productive finance. All over the world, we’re starting to see negative interest rates.

Negative interest rates are a signal something is very wrong with finance, and the broader economy. Normally when you put money into a bank account, you get paid some interest on your savings. This is because a bank account is essentially a bank borrowing your money and using it to finance other loans that go into productive purposes like building factories. In return for your deposit, the bank gives you a cut of the action, usually a minimal interest rate. A government bond works the same way as a bank account, but it finances government spending and mostly bonds help finance savings for really large corporations and funds. Like a bank account, buying government bonds is a safe way to store assets, and get a little bit of a return.

But today, many bonds are paying negative or near-negative interest rates, which means that when you put money into government bonds, you lose money over time. Joe Weisenthal wrote up what is happening, using an agricultural metaphor of too much grain seeking too little storage.

In other words, to store money at a bank requires the existence of some other borrower who will pay the bank.  As such, just as you’ll pay more to store grain when grain is abundant and warehouse space is scarce, you have to pay more to hold money when savings are abundant but demand for borrowing is scarce.

This is the world we have today. Thanks to ever-increasing wealth concentration and meager growth across the developed world, you have some people sitting on incredible piles of cash and a shortage of people with robust opportunities to borrow and use that cash.

I’ll continue this metaphor to describe the job of the Federal Reserve. Let’s say we are an economy with only corn. Every year we eat 95% of the corn we grow and keep 5% of it as seed to plant. The Fed’s job is to make sure that the seed corn gets planted in a fairly reasonable manner. Zoom out to a more complex economy. That 95% is all the stuff we make and use, and that 5% is all the factories and whatnot we build so we can have more the next year. The Fed oversees getting our savings put into productive investment, and it uses the banking system/capital markets to do the planting (aka financing).

The Fed works through interest rates, which is to say, the price of money in markets where lenders and borrowers meet each other. Often you hear that the Fed raised or lowered ‘interest rates,’ but that’s not precisely accurate. There are many markets for interest rates, everything from credit cards to mortgages to junk bonds to an endless variety of swaps. The Fed changes interest rates in one particular market for money wholesalers (aka big banks). Most other money markets, like mortgages, credit cards, business lending, and so forth, are supposed to be referenced to the market in which the Fed operates, which is why the shorthand on the news is the Fed raised/lowered rates.

That’s the theory anyway. But the Fed’s tools, and those of most central banks, aren’t working like they should.

Very low or negative interest rates mean that investors can’t find any place to place their savings. Investors perceive there are no more factories to build, no distribution centers to create, no new energy systems to research, no more products to create. You can only stuff money under a mattress, and the price of mattresses is going up. Our financial system, in other words, is acting like we have no more social problems to profitably solve.

In a world with a looming climate crisis and endless poverty, it is extraordinarily weird to act like there is no way to profitably use capital. There is in fact an entire ideology behind this bizarre view; Democratic Presidential candidate Andrew Yang wants to cut every American a thousand dollar automatic monthly dividend, because automation has solved everything, created too much production. When asked about climate change in a debate, he actually said it’s too late and we must move to higher ground. Yet he also seems to believe that all problems he can identify have been solved by automation. Yang is a fringe candidate, but negative interest rates are the entire financial system agreeing with Yang’s view.

This problem, what economists sometimes call a ‘savings glut,’ has been with us in one form or another for decades. After the financial crisis, the problem of a lack of productive outlets for capital investment got so bad that important academics like Robert Gordon began arguing that we’ve simply invented everything important. His argument caught on in important circles. . .

Other thinkers, led by former Obama officials Jason Furman and Peter Orszag, argued that a small group of superstar firms have detached from the rest of the economy. Orszag and Furman do not conclude whether those firms have either managed to capture market power or figured out a special sauce whereby they are just more productive than everyone else in the economy. Perhaps Google is a monopolist, or perhaps Google search really was that much better than AltaVista, Yahoo!, Bing and so forth. In this framework, Orszag and Furman essentially agree with the Thomas Friedman-esque argument that globalization and technology has driven more productive companies to capture more power, and erode the share of output going to labor. McKinsey is even selling superstar firm gibberish to its clients.

So maybe that’s the problem. There’s nowhere to put money because either everything’s been invented, or because some firms are just better than everyone else.

Sorry, but I don’t buy it. If you give three billion people supercomputers in their pockets and connect those supercomputers into a massive real-time information grid, a few of them are going to think of useful things to do. Combined with advances in material sciences, biotechnology, genetics, optics, and just, well, more educated people than ever before, there are still amazing businesses to create. The argument against human capacity to innovate doesn’t make any sense, unless the people debating want to avoid discussing the key problem, which is power.

What is actually going on?

The most likely explanation for negative interest rates is far simpler. The economy has become a giant kill zone. In venture capital circles, the term “kill zone” has become quite popular to describe the phenomenon of having no places to profitably invest.

O’Reilly Media founder Tim O’Reilly talks of big tech companies “eating the ecosystem.” Others are talking about a “kill zone,” where new and innovative upstarts are throttled. For some startup founders, acquisition by a big company is the dream — they’re happy to walk away with a small fortune and move on to the next stage of their careers. But there’s a danger that big companies, being less emotionally invested in the companies they acquire, will leave them to wither on the vine.

And even more importantly, a kill zone can result not from acquisition, but from the threat of overwhelming competition. If founders believe that big companies will copy their innovations cheaply and compete them out of the market, they’ll never spend the time and effort to create those innovations in the first place.

Maybe what’s happening is that we can’t invest profitably, because there are monopolies everywhere you try to put money to work in the real economy.

Economists Simcha Barkai got to this dynamic in a paper he wrote in 2017. Barkai was interested in the decline in the amount of corporate output going to labor. He concluded this decline is not occurring because capital is getting a large share of income. Capital investment is going down even faster than labor share. There’s less spent on workers, and less than that spent on robots. So if labor share is down and capital share is down, what is up? Profits. The driver, Barkai found, is firm concentration is up across the American economy since 1985. This trend is more pronounced in higher concentration sectors, and less pronounced in lower concentration sectors.

Barkai doesn’t conclude that this change is policy driven, and doesn’t argue it’s a result of lax antitrust enforcement. But what his argument does imply is that large profits that cannot go into productive capital investment or to workers will instead go into government bonds, pushing interest rates for ‘safe assets’ down quite low, or even into negative territory. There’s just nothing to invest in, because you can’t put money into monopolistic markets and expect a return. The kill zone, in other words, is everywhere.

Investment in a Low Interest World

But this works from the other side as well. . . .

Continue reading.

Written by LeisureGuy

13 August 2019 at 10:27 am

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