Although my book-in-progress is called The Economic Consequences of the Pandemic, a lot of it will deal with changes that were already underway, and have only been accelerated by the pandemic. This was also true of Keynes’ Economic Consequences of the Peace. The economic order destroyed by the Great War was already breaking down, as was discussed for example, in Dangerfield’s Strange Death of Liberal England.
Amid all the strange, alarming and exciting things that have happened lately, the fact that real long-term (30-year) interest rates have fallen below zero has been largely overlooked. Yet this is the end of capitalism, at least as it has traditionally been understood. Interest is the pure form of return to capital, excluding any return to monopoly power, corporate control, managerial skills or compensation for risk.
If there is no real return to capital, then then there is no capitalism. In case it isn’t obvious, I’ll make the point in subsequent posts that there is no reason to expect the system that replaces capitalism (I’ll call it plutocracy for the moment) to be an improvement.
But first let’s look at the real 30-year bond rate. The US Treasury is currently offering an inflation-protected 30 year bond at a rate of -0.3 per cent. That is, if you buy the bond at say, age 35, you can get your money back, less a 10 per cent reduction in real value, when you are 65. This rate has fallen from 2 per cent, when the bond was introduced in 2010, and started declining sharply in late 2018, before the pandemic, and while the Federal funds rate was rising.
In thinking about the future of the economic system, interest rates on 30-year bonds are much more significant than the ‘cash’ rates set by central banks, such as the Federal Funds rate, which have been at or near zero ever since the GFC, or the short-term market rates they influence. These rates aren’t critical in evaluating long-term investments.
The central idea of capitalism is, as the name implies, that of capital. Capital is accumulated through saving, then invested in machines, buildings and other capital assets to be used by workers in producing goods and services. Part of the value of those goods and services is paid out as wages, and the rest is returned to capital, as interest on loans and bonds or as profits for shareholders. Some of the return to capital is saved and reinvested, allowing growth to continue indefinitely. Workers, on this account, can become capitalists too, by saving and investing some of their wages. At a minimum, they should be able to save enough, while working, to finance a decent standard of living in retirement.
But what happens if there is no return to capital? The collapse of interest rates on government means that’s already true for anyone who wants a secure investment. And the situation isn’t any different for the two remaining AAA-rated corporate borrowers, Microsoft and Johnson and Johnson. Microsoft is currently offering a rate of 2.5 per cent on 30-year bonds, and has exchanged lots of outstanding debt for new bonds at that rate (paying a 40 per cent premium for higher-interest bonds). That’s a real return of 0.5 per cent if you assume that the Fed sticks to its current 2 per cent target and hits it on average. (There’s a lot more room for inflation to surprise on the upside, in my view). If you allow a 15 per cent risk that Microsoft will go bankrupt some time before 2050, the expected real return falls to zero.
To complete the picture of returns to capital, we need to look at stock markets and corporate profits. That’ll be the subject of another post.
John Quiggin 
The end of interest! Capitalism has lost its mojo!
I look forward to John’s thoughts on Apple, currently the world’s biggest company by market cap ($1.6 trn). It has a trivial $13bn in debt; its financial problem is that of Croesus, where to stash the $200bn pile of loot. The business model is insane: persuading millions of rich kids to spend $1000 on a device with essentially the same capabilities as a $33 entry-level smartphone in South Africa. https://www.samefacts.com/rbc-smartphone-review/ The iPhone is better designed, better made, and absurdly overpowered for 99% of uses. (It also has biometric ID, missing on the cheapo.) I can understand paying a significant premium for quality. If you are going on a wilderness hike, it makes sense to pay $75 for a Leatherman or Victorinox multitool, as your life may depend on it, rather than $11 for a Chinese knockoff. The Apple premium isn’t 7 x, it’s 30 x.
But setting ahem… productive… capital to work making and selling widgets still generates a profit, surely? Else the system really would grind to a halt, à la Marx. Keynes’ Euthanasia of the Renter has just arrived by an unexpected path.
I think capitalists are still doing what they do best. That is making money while ignoring worker rights, human rights and “little” negative externalities like catastrophic climate change. They do it by morphing themselves and the system, seemingly at will. When a finance writer like Alan Kohler can get an article into The Australian which says “MMT = Keynes 2.0” that says something and it needs unpacking. That’s two traditional cuss words, under neoliberal orthodoxy, in one algebraic sentence. Why has this been permitted in the neoliberal Australian?
Why have Keynesian thinking and even the letters “MMT” been permitted to enter mainstream discourse, once again for the former and for the first time in for latter? The answer is simple. The elite capitalists and their servants in government now have reasons to legitimate the almost endless creation of fiat money. They have perfected the art, over the last couple of decades, of creating asset inflation without significant goods and services inflation. They have perfected the art of (electronically) printing lots of money but controlling which circuits the money enters. The new money enters the asset circuits but not, in the main, the goods and services circuits.
Money which appears the same -it is denominated in the same dollars – is not the same. There is a real-world equivalent to this phenomenon in the ocean systems of the world. These real-world phenomena are called clines. A physical cline is a measurable gradient in the characteristic(s) of a physical component of a system across the range of a system. In the ocean there are haloclines (gradients in salinity) and thermoclines (gradients in temperature). Other gradients are possible, like gradients in oxygen content and CO2 content. In some cases clines, operate to stop or reduce ocean system mixing which otherwise would be expected.
I suspect clines exist in the money system. Different financial instruments, all denominated in dollars, nevertheless have different characteristics. A greater preponderance of one type of instrument in one segment of the economy may indeed function to set boundaries to full system mixing and thus limit inflation, for example, from mixing evenly through the whole system. This seems a reasonable hypothesis for investigation with regard to differential inflation across the economic system.
The capitalists, including macro-capitalists employing “quants” and micro-investment capitalists like my son employing software engineering and mathematics skills, are adepts at exploiting characteristics of the financial system via intuitive, deductive, inductive reasoning, systems analysis and mathematical techniques. To suppose that they, collectively and by learning from each other’s moves have not “emerged”, “evolved”, developed or hitch-hiked upon, methods to exploit and/or even engineer differential inflation to their own ends would be to be as unimaginative as the smartest capitalists are clearly imaginative.
Leftists may indeed be imaginative but their imagination and creativity is inoperable in the capitalist system. Their imagination and creativity does not enter the system at all, at least until the juncture of revolution. It enters only imaginations and consciousnesses and it can change consciousness in the human agent but it cannot enter the formal system of capitalism. On the other hand the imagination of owners, quants and investors continually enters the capitalist formal and thence real systems. Only those imaginations evolve the system. Voting is the only other route to evolve the system short of revolution and we can say to date that voting has been relatively ineffective because of the control of public consciousness exerted by the capitalist media.
In summary and referring to the end of interest, I am saying it is an intentional or quasi-intentional policy by the dominant capitalists (strong hypothesis) or an evolved result of the intentions and methods of their competitive-cooperative oligopoly behaviors (weak hypothesis).
Ikonoclast writes:
“The elite capitalists and their servants in government now have reasons to legitimate the almost endless creation of fiat money. They have perfected the art, over the last couple of decades, of creating asset inflation without significant goods and services inflation. They have perfected the art of (electronically) printing lots of money but controlling which circuits the money enters. The new money enters the asset circuits but not, in the main, the goods and services circuits.”
I concur with the gist of the characterisation. There is an older expression for “elite capitalists”, namely ‘high finance’. The details of the financial deregulation (including the so-called financial product innovations), which have happened starting in the US, being enhanced by Thatcher’s ‘big bang’ and spread gradually throughout the ‘global economy’ matter. The changes in the institutional environment are such that the relevant parameters do not fit into the Keynesian macroeconomic models.
The best illustration of “controlling which circuits the money enters” is the purchases of privately generated debt by the Fed (ie QE).
I take it that “services” includes labour services (eg wages).
This will bankrupt defined benefit pension schemes.
Ernestine Gross,
I feel encouraged when we arrive at some characterizations which agree at the general gist level at least. We are using different theories, methods and assumptions, to some considerable extent, to analyze the same extant phenomena. It’s a bit like like two different estimation methods getting ball-park agreement on quantification. It does increase confidence that one is in right the ball-park.
I use a bit of Marxian thinking, a bit of Capital as Power (CasP) thinking and a bit of physical system analogy thinking in a synthesized fashion. You use (I assume) Analytical Economics plus Institutional Economics. There are clear crossovers between both approaches as they both both imply systems analysis and institutional analysis. This thought line leads me to take much more seriously, than I have before, this sentence of yours:
“The changes in the institutional environment are such that the relevant parameters do not fit into the Keynesian macroeconomic models.”
Smith9,
Superguide says:
“Be very careful before taking your super benefits out of a defined benefit super fund.
Many of these super funds have been around a long time and the benefits members receive are often very generous – usually much more so than what members of other super funds receive.
The key advantage is that you are guaranteed to received a specific (or defined) benefit when you retire, irrespective of what’s happening in the investment markets or how the super fund is performing.”
The key word is “guaranteed”. In Australia, at least, our government defined benefit super schemes are guaranteed (from general revenue if need be) by the government. An Australian defined benefit scheme is unlikely to ever fail unless the government and country fail completely. That is to say the government would have to fail and Australia would have to become a failed state. For sure, all bets are off if that happens.
Short of failed state status it is conceivable that a government under great economic duress might freeze defined benefits (remove inflation indexing). Technically, define benefit schemes cannot go bankrupt whereas market linked super schemes can. However, while the stock market pays return and while not all stocks collapse to zero, any put a very badly managed market linked scheme should not go bankrupt. These are my understandings at least.
Iko, government defined benefit schemes will be fine because the government can tax the population to pay for them.
But private companies cannot. If you have a private defined benefit pension of $50,000 per year and the fund is earning 4% per annum the fund needs $1.25 million of assets to generate the $50k. (Actually, less than that because you don’t live forever. How much less? Ask an actuary.). But if the fund earns only 1% per annum it needs $5 million of assets to generate the $50k pension.
Where does it get the extra $3.75 million per person in pension mode? It doesn’t. It goes bankrupt.
Smith9,
That seems very possible. I am not an expert on super benefit schemes. But what you say sounds right. Without any government guarantee they go bust. I think we will see a lot of that soon. And market-linked schemes like my wife’s will simply lose money year after year and dwindle to nothing, perhaps sooner rather later. In 10 years time, the super of many Australians will have failed, so yes they all will be back on pension. The Australian pivatised super system will fail and government will again have to carry the whole burden, if it can from consolidated revenue, but in a much decayed economy. So yeah a sh*t storm of personal and national failures ahead.
Out of fury and frustration, I have been venting and peppering this blog about how corrupt Australia really is. There is also much evidence of extensive corruption and profiteering in the super and super insurance industry. So yes, expect a raft of super and insurance failures soon along with people losing all their savings.
Yet micro-investors like my son can currently make large returns on the market. My son is currently averaging 40% returns on the market two years running. Of course, that is a short run in the scheme of things and he is taking risks and could still come unstuck. He knows that himself. However, he is already hedged and has a proportion of his portfolio more safely tucked away. Even hedged and with part of the portfolio secure he is still making an annualized average of around 35% annual on a per month basis, again on average. One has to wonder about the unreality of the whole system in addition to the endemic corruption in it. Money flows have almost nothing to do with production any more. It’s almost all about speculation and rentier income.Given that that’s the case. A time must come soon where there is just not enough real stuff for people anymore, irrespective and their having money. I expect a total collapse into anarchy on a global scale.
There is difference between interest on government debt and return on capital for firms. While you are right that interest on government debt decreased, it is not the case that return on capital did according to economists who study the difference.
Nitpick :”Some of the return to capital is saved and reinvested, allowing growth to continue indefinitely.”
Without either continuous productivity growth or exogenous demand growth (population growth, traditionally), growth via partial reinvestment can only continue indefinitely as an infinite series with a finite limit — in ever-decreasing increments.
This raises an often-overlooked point: –
In “ordinary” times (the long 20th century), with population growth + wage growth at 2% pa, the market for the products of a given investment doubled in 35 years, making the investment safer than the same investment would have been in a static market. A town with two busy shoe shops mid-century would need four shoe shops 35 years later. Entrepreneurs and lenders both knew this, even if unconsciously.
The market growth in the background of the 20th century provided a “tail wind” of reduced risk to lenders. Lenders’ willingness to lend for investment was higher than should have been expected absent this background of growth.
Ordinary is now over, finished, done with. The tail wind is dying out and will become a head wind absent policy changes.
—
There is plenty of return to the existing capital of incumbents, but they have little reason to make new investments. Entrepreneurs can’t compete with incumbents, with little innovation happening.
Lenders are casting around desperately for anything that looks investment-like. That explains why silly ideas like cryptocurrencies and blockchain, short term office space rental (WeWork), electric scooter rental, and self-driving cars have been able to attract so much money and attention, and why so much effort is being put into breaking rules protecting consumers and workers, as with taxi and delivery services (Uber & co), hotels (AirBnB), and shadow banking.
People with incomes and no-one to lend to are also desperate to park their money somewhere, explaining the massive price increases for collectibles (blue-chip stocks and bonds, real estate, art, etc.)
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