The conventional wisdom of conservative economics since the publication in 1963 of Milton Friedman and Anna Schwartz’s A Monetary History of the United States was that the Great Depression was caused by inept monetary policies. Instead of flooding the system with liquidity, the government sought to stabilize the currency. Thus bankers didn’t have enough money to loan and consumer demand collapsed. The other leg of Friedman’s stool is based on the notion that cutting taxes on capital gains in downturns will stimulate investment in productive assets, thus leading the rebound. Professor James Livingston of Rutgers has just published a brilliant series of articles that points to another cause of the crash; one that has eerie parallels to our current crash.
The Great Depression was the consequence of a massive shift of income shares to profits, away from wages and thus consumption, at the very moment—the 1920s—that expanded production of consumer durables became the crucial condition of economic growth as such. This shift produced a tidal wave of surplus capital that, in the absence of any need for increased investment in productive capacity (net investment declined steadily through the 1920s even as industrial productivity and output increased spectacularly), flowed inevitably into speculative channels, particularly the stock market bubble of the late 20s; when the bubble burst—that is, when non-financial firms pulled out of the call loan market in October—demand for securities listed on the stock exchange evaporated, and the banks were left holding billions of dollars in “distressed assets.” The credit freeze and the extraordinary deflation of the 1930s followed; not even the Reconstruction Finance Corporation could restore investor confidence and reflate the larger economy.
As you can see from the chart at the top, this “massive shift of income shares to profits and away from wages” is also the most striking characteristic of the Bush Era. Starting in 2001, corporate profits soared and wages declined. One might argue that these large profits would have been plowed back into productive investments, but actually they were returned to shareholders in the form of dividends and stock buybacks. Livingston notes that even Friedman’s greatest disciple Alan Greenspan was dissapointed.
Greenspan concurred: “intended investment in the United States has been lagging in recent years, judging from the larger share of internal cash flow that has been returned to shareholders, presumably for lack of new investment opportunities.” (Age of Turbulence, p. 387)
So where did all that money flowing into the pockets of stockholders go? Into real estate speculation. Thus the Big Lie of Reaganomics is revealed for all to see. Radically reducing taxes on the rich does not stimulate productive investment, it merely stimulates speculation. Needless to say, John McCain’s whole economic policy is based on this fallacy.
The larger question which the Obama administration, faced with the task of rebuilding America, will have to ask is this. At a time when China, India, Brazil and many European countries are making extraordinary investments in productive capacity (Broadband, alternative energy, infrastructure, biotech, education and health care), why are America’s corporations so bereft of productive opportunities that all they can do with their mountains of cash is buy back their own stock?