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Why the rich are getting richer


Businessman examining money

One of the problems in economics, an academic discipline that consists of little else but problems, mostly intractable, is that the models used to describe human activity tend to be static.

There is little attempt to alter the models as the system changes. History is ignored. Instead, there is an attempt to establish supposedly timeless rules, to mimic the physical sciences.

One example of the folly of this approach is the emergence of the absurd casino that has taken over the global monetary system, the so-called derivatives market (gambles ‘derived’ from conventional transactions). This has never been seen before, and it undermines traditional economic theories.

The global stock of derivatives, according to the Bank for International Settlements, is about $700 trillion, an unthinkably large (albeit notional) amount. It is so large that traditional economic theories about money supply, and its relation to factors like inflation and growth, have been undermined. It has become difficult to define what money actually is. That is why the US monetary authorities jettisoned M1, the most commonly used measure of money supply. It meant that one of the most popular economic theories, monetarism, was rendered useless because it is no longer possible to be confident about what money supply is.

Another example of the shortcomings of conventional economic theories is identified by economist Alan Nasser. He does something that is unusual for economists. He observes history, noting that as industry has matured, the fundamental rules of economics have changed.

The argument is that in the nineteenth century, during the early phases of industrialisation, growth was dependent on the level of investment and the formation of capital (China is still in that phase). Up until about 1920s, that net investment was necessary to keep economies growing.

But as companies became more efficient and innovative, their requirement for surplus net investment eased. Once the basic infrastructure of industrialisation was established the need for additional funding eased. The cost of producing goods also declined because of technical innovation. Capital formation became less significant because businesses became more innovative, a process that has continued ever since.

But economics has stayed firmly fixed in the nineteenth century, focusing on capital formation and its relationship to output. Nasser questions this assumption, which continues to underpin most economic policies in the developed world: 'We are to believe that the surplus that is currently channelled into financial speculation in derivatives and foreign exchange markets, or sitting idle in the coffers of giant private enterprises, should be diverted back to productive investment, which in turn would make possible economic restoration.'

What Nasser calls the 'atrophy of net investment' means that in the late stages of capitalism, capital is in excess and investing it in productive capacity will not generate sufficient profits (he is talking mainly about goods, the argument seems less compelling with services, which have not been subject to the same level of innovation).

He cites the economist Keynes, from Economic Possibilities For Our Grandchildren, who imagined the discarding of a social system premised on giving money a special status, which creates a financial elite. Keynes wrote: 'When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years.'

It is a challenging idea. Nasser claims that government investment and consumption, and not what the capital markets do, are the only viable means of catalysing growth. This is exactly the opposite of what has happened since the global financial crisis. Governments in developed economies have savagely cut their investment, and consumption has been anaemic. Meanwhile, the financial sector has continued to grow and create extreme wealth. In America, the concentration of wealth in the hands of the top 1 per cent of the population is a reflection of financiers’ success. In Australia, finance is now the largest industry sector.

Why have the controllers of capital thrived when, if Nasser is correct, the importance of private capital in late stage capitalism has declined? The reason is that the finance sector has become skilled at the art of making money out of money. Investing capital in productive capacity is not a good option because the returns are not there. That is why American corporations are sitting on mountains of cash.

But finding ways to manipulate the financial system to create more money from money – such as the derivatives casino – can pay off handsomely. Sure, it may look like a Ponzi scheme, it is a Ponzi scheme, but on its own terms at least it is profitable. Far from the democratic re-ordering of society and the weakening of the money class that Keynes imagined, what has happened is the opposite: an increasing polarisation of wealth and the entrenchment of a financial elite.

This polarisation is less extreme in Australia, where we still have a middle class. But we have our own capital-driven Ponzi scheme – the residential property market. This, too, has become an exercise in making money out of money. In the 1970s, only a third of Australian banks’ loans were on real estate. Now, well over half of the banks’ lending is on real estate, especially residential mortgages, which are basically investments in unproductive land. Meanwhile the banks are less reliant on business loans, which are an investment in productive capacity. These loans attract a significantly higher interest rate than mortgages and most require property as collateral.

The implication is that the financial sector is becoming progressively disconnected from the reality of economics in late stage capitalism. And the mainstream economics profession is aiding this detachment from the real by pursuing timeless scientific principles that do not exist.

The consequences of allowing such a parallel universe to develop became clear enough during the global financial crisis. But the basic lesson, that the money class should not be allowed to set its own rules, has not been learned.

David JamesDavid James is a business journalist with a PhD in English literature. He edits Personal Super Investor.

Money examination image by Shutterstock.


Topic tags: David James, economics, finance, investment, Ponzi schemes, wealth, production, property



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Existing comments

Thanks, David. Your initial paragraph says it all: "One of the problems in economics, an academic discipline that consists of little else but problems, mostly intractable, is that the models used to describe human activity tend to be static." And on several accounts: Lacking a dynamic orientation, economics remains an "academic discipline" which uses descriptive models and not a science which provides an explanatory framework for significant variables. Bad theory leads to bad practice. There is the Cuban joke that "it works in practice but it does not work in theory." Bernard Lonergan, a Canadian Jesuit (1904 - 1984), perhaps better known as philosopher and theologian "discovered" the science of economics between 1930 and 1944 (turbulent times!) That discovery is chronicled in Michael Shute, Lonergan’s Discovery of the Science of Economics. Lonergan Studies: 21. Toronto: University of Toronto Press, 2010. Like Alan Nasser, Lonergan was interested in "political economy"--the exigence to provide intelligent advice to enable choice by democratic men and women, not handing over decisions to an "elite" bureaucracy nor trying to gamble your way to standard of living. While mainstream economics speaks generally of aggregate firms and aggregate households, it does not acknowledge the functional differentiation and explanatory significance of two types of firm (basic and surplus) and concomitantly, two monetary flows. It does not build theory as an explanation of real-life businesses and finance of real-life people, but constructs and imposes conceptual models. Money (and finance) has true value in the context of its economic function. Money flow is a kind of measure of economic production and sale, or redistribution of ownership. Today, though, money is being treated as a commodity. See: For a New Political Economy: Volume 21 (Collected Works of Bernard Lonergan) University of Toronto Press, Scholarly Publishing Division (November 27, 1998)

Tom Halloran | 19 November 2014  

Thanks David; a really excellent article. Could I also add another substantial and bizarre twist that has driven financial inequality and injustice since the GFC, namely the printing of vast amounts of new money with which central banks then buy vast amounts of financial "assets". The assets of course are held by the rich and they essentially get all the "free" money, with which they can buy more assets which go up in value because of all this demand. In addition, they can/do leverage their inflated assets to buy even more of them using borrowed money at extremely low current interest rates. And so it all goes round and round and up and up. It is of course another huge bubble or indeed Ponzi scheme, as you say. And on the other hand those in jobs have static or decreasing salaries and those without a job have services and social payments taken away or decreased!! Those newly-weds that want to buy a house find the "asset" has gone through the roof so they cannot, and rents have gone up commensurately. Absolutely brilliant social policy! If instead governments "gave" the money to the poor they would spend it on goods (necessities), so growth would go up and jobs would be created; or as well spend it on needed infrastructure to again provide jobs and let people have their own money to spend. Why don`t we do this...as Pope Francis says this is all a total disgrace? Because it is regarded as SOCIALISM! ...while giving loads of dosh to the mega rich is obviously something else. And somehow it is OK for central banks to print lots of money to essentially give away (it seems hardly possible that they will be able to sell their assets without causing a crash) but not the government itself, because it will increase their "deficits" presumably. But ironically when the bubble ultimately bursts they will have to pick up the cost anyway...or at least we tax-payers will, and the poor will suffer terribly.

Eugene | 19 November 2014  

Jesus said that to him that hath shall be given, and to him that hath not shall be taken away - – a fair statement of economics through the ages. The World Bank has stated that economies suffer when the incomes of the top 5% grow increasingly more disparate from the rest of their society. How can the insatiable greed of the richest people today be stopped? .Social sanctions can have an effect. 1 Human nature does not change. It has potential to be self-sacrificing, public-spirited, honest, honorable, generous . . as well as to be greedy, lazy and violent. Our culture at present worships greed, rivalry, envy, selfishness, conspicuous consumption, malice and winner-takes all. Everyone of goodwill can work to shift the culture 2. Lotteries promote the wealth gap with enormous prizes for a few and also promote the hope for enormous wealth. Lotteries could have top prizes limited to the cost of an average home plus a fortnight's holiday abroad for two. Then there would be more prizes 3. Rich people can be honored by what they give away rather than what they collect. People who are too rich can be shamed and feel shame.

Valerie Yule | 19 November 2014  

Thank you for your informative and timely article.

P Russell | 19 November 2014  

Let’s begin with a story. Robinson, aka “Midas” Crusoe washes up on his desert island. He spends a few days knocking down coconuts to eat, fishing in the rock pools and trapping rain water to drink. One day, he discovers reefs of gold in some rocks. Gold! He’ll be fabulously rich! So he devotes his time wholly to eking out that gold, smashing the rocks and panning with coconut fronds (go with me on this) … and soon dies of thirst! RIP. A plausible scenario? You know, perhaps after a day or so of gold-mining, the pangs for water, not to mention food, just might determine an alternative schedule of preferences, even for our Midas version of Robinson. Likewise, how likely is it that everyone in our putative “late capitalist” society will continue to devote all their resources to “making money out of money”, and no-one actually create real products – even out of a much-maligned capitalist lust for windfall profit that would manifestly beckon in the circumstances – so that everyone suffers huge drops in standards of living, and there’s widespread death resulting? As long as he’s on a desert island, Robinson’s mined gold doesn’t raise his standard of living one iota, and in fact he’s doomed quick smart if he devotes his activities entirely to mining gold. Likewise, if there’s a shift to the making of nominal money rather than increasing real purchasing power – ie people become like Midas Robinson and forget that the value of money depends on its relation to a stock of real goods – we’ll be surely doomed, as Nasser implies. The trouble with this very ivory-towered theory is: people overwhelmingly are not as incredibly stupid as “Midas” Robinson Crusoe. The actual scenario is this: there are guns trained on our Robinson whenever he tries to harvest coconuts or trap rain water. The guns are taxes, laws, regulations, red tape and so on. But there’s virtually no downside on him mining his gold rocks (ie, investing in derivatives), and if he’s important enough (“too big to fail”), governments will rip real wealth from everyone else to sustain his fruitless activity. Voila the GFC and the inability of most governments to exit it. The notion that we need the state to boost growth, when it’s government that’s systemically diminished any incentive for the production of wealth in honest businessmen, and it’s government that is manifestly incompetent at economically producing the simplest widget, would be laughable if it weren't so outrageous.

HH | 24 November 2014  

HH is right to distinguish between the flow of money and the flow of goods and services that constitute a standard of living. I would push it further in two directions: first, to suggest that the flow of money needs to be adjusted to the flow of goods and services, and; second, to suggest that the exchange of money, of land and property, of shares, of second-hand goods etc. adds nothing to the flow of goods and services. It merely transfers ownership from one person to another. Furthermore, if we are to understand how an economy works (rather than trying to predict the price of goods and services), we need to distinguish between Robinson spending his days “knocking down coconuts to eat, fishing in the rock pools and trapping rain water to drink” and Robinson using his creative ingenuity to discover and produce new technologies that will make it easier and less time consuming to do those things. But he can’t devote himself solely to one or the other – there must be some balance between them. Yes, as Tom Halloran notes referring Bernard Lonergan, there are two types of firms and while economists continue to aggregate their flows, they will continue to miss the significant variables that constitute an economy.

Artfulhousing | 25 November 2014