Before we step any further we need to reassess the economic engine, its habitat and condition and the conflict between the two.

Capitalism and its economics have been the subject of much debate since at least 2007.  At its heart it represents the engine of economic growth, of technological progress, of the efficient allocation of resources, the determination and distribution of return/prices (wages, interest, dividends) key to attracting risk takers and capital and of the accumulation of capital required to produce as well as the development of markets for the trading of goods, services and assets.

Capitalism’s core engine has taken us far in at least one direction.  Two of its main alternatives socialism and communism have long since foundered on the human condition and the many issues associated with their decision making structures, and while less susceptible to the same issues, capitalism is nonetheless not immune to corruption of its process, concentration of power (asymmetries etc) and impairment by its own emergent traits.   

As an ever lasting engine of growth, capitalism has been increasingly beset with  problems: it has required ever lower interest rates and monetary stimulus to keep it chugging along, at a rate of growth set by man, I must add, and not its own mechanics; it has become increasingly burdened with higher levels of debt, financial instability and as a result has become itself susceptible to natural demographic realities; indeed, the financial instability has not been wrought of its mechanics but the aims and objectives of the social and moral structure it inhabits.  It appears as if the construct we know as capitalism has been thus engineered for one trajectory and one alone, whereas outcomes of natural forces would adjust to fit the natural dynamics of the universe it inhabits.   For anyone doubtful of what I believe is an overly “consumerism” bent of capitalism I would suggest watching the BBC documentary “The Century of the Self”.

Capitalism’s frame has become increasingly susceptible to financial risk emanating from the wider swings in asset prices we have seen over the last two decades, swings that are related to the increasing asset focus of money supply and higher levels of debt, themselves a consequence of lower interest rates and emerging structural instabilities (increasing income inequality, weakening productivity etc).  

While natural habitats have orders these are largely, and often painfully, self regulating: too many top predators and not enough food for the predators, not enough top predators and not enough food for those lower down the order and populations adjust.  Many of the natural adjustment mechanisms within the capitalist/financial system have been overridden, largely by monetary policy (lower rates, QE, asset price support) in developed economies and finally by central government support of financial systems.  While we have been manufacturing/engineering an economic and financial outcome, the outcomes themselves could not really be judged to be a great success: we cannot even raise interest rates it would appear without the financial system taking fright and holding the world hostage. 

It looks increasingly likely that engineering of our economic and financial system will continue, as failure to do so would bring down social and financial edifices key to the construct, but we have yet to define the parameters of operation and balance of that universe.  There has to be some form of order that will provide both stability and regeneration avoiding the restrictions and weaknesses of a controlled habitat whilst allowing for the innovation, creativity, risk taking and individual freedom of a competitive market construct.  

The days of “perfectly efficient markets” (financial, labour, capital, resource etc), if they had ever existed in the first place, have likely passed.  And this is one of my key concerns: that the models that economics possesses are of the general equilibrium kind with efficient/dynamic self adjustment to imbalances and shocks. Instability does not compute.  Secondly, the objectives of efficient/general equilibrium models are not those of the financially engineered modern global economy with substantial social and environmental issues to deal with.  There is a divergence and with this divergence comes the inability of inappropriate “model type solutions” (-ve rates, inflation expectations) to solve the full spectrum of our economic problems. 

Some continue to believe that the decision making framework that allocates between current and future expenditure is impaired and that all we need do is create the necessary differential – lower the cost of capital to increase the return on capital and hence to stimulate investment or increase the cost of holding money to increase its consumption focussed velocity – to stimulate expenditure, or that all we need do is to fund massive infrastructure investment and the animals spirits lacking and critical to the operation of the machine will return.  I do not believe that this is the core of the problem, although indeed the very wealthy are not spending and corporations are not investing as before in a number of economies. 

“We” may only see the problems that are the focus of  “our models” as opposed to the problems of the frame and dynamics.   Part of the identification issue is likely due to the close association between growth and monetary expenditure such that any solution that increases monetary expenditure is at first sight a relatively easy one.  What we ignore here  is the impact of all the accommodation/engineering such that we lose sight of our positions relative to where we might otherwise be without it.

It is likely that the frame is exposed to at least three key emergent forces:

The one is the increasing income inequality in the system as profits as a percentage of GDP rise and income growth to the top 1% or so increases relative to the rest.  Declining income growth rates amongst the majority alongside rising asset prices in a declining interest rate and increasing asset focussed money supply may have also been a factor behind rising debt financed consumption – note US home equity withdrawals. 

Demographic changes that would likely alter the growth in productive capital trajectory of the economic frame and that outside of an accommodated monetary environment may well have been accommodated naturally:lower growth, capital depreciation and natural adjustment of the capital stock and its valuations.   Debt accumulations  relative to GDP have likely been made worse by changing demographics and the ability for systems dependent on productive capital values to adjust to changing frame sizes: this forced accommodation of the system set the frame up for an almost near death experience as defaulting assets and declining valuations came back through the core of the financial system.  Most economic models ignore the financial imbalances in the system framing these imbalances as either one of excess saving or insufficient investment.

Transitions between developed and developing economies that exacerbated employment and income growth and the transitions themselves that would likely have been influenced by excess consumption growth/income growth relatives in developed economies at this time etc etc.

We do need the engine, the competition, the innovation, we do need the risk and the consequence, but do we need “capitalism” in its current emergent engineered form?  What is its mission?  Is it just growth for growth’s sake and consumption for the same?  What are we building?  It would seem that growth in expenditure and increases in the valuation of capital seem to be the main objectives and with the excess focus of monetary stimulation on assets and increasing fragility of the financial system as leverage and asset focussed money supply increases, expenditure becomes an increasingly financial imperative: i.e. without a certain growth in expenditure asset markets collapse and with collapsing asset markets so does the monetary economy.     

The capitalist “model” at its heart relies on rationale fully informed individuals able to make a complex series of decisions regarding both the present and the future, a present and future that would also include issues of environmental sustainability as the impact on progeny would necessarily need to be considered.  Problems like poverty (an imbalance in the spectrum) should likely disappear or never exist in the first place in a world where all individuals are multi period rationale and all available information about decision making out in the open.  Likewise increasing inequality, that is a perverse imbalance in the distribution of income and wealth that jeopardises the balance, stability and durability of growth would not likely exist: a rationale structure would likely find solutions to this source of system instability as it is the outcome of an imbalance in numerous areas. 

What we have is an inherently unstable system, not all are rationale or fully informed, and unstable systems that are aggressively supported in their expansion risk ending up with large potential shocks.     

I very much doubt whether we really have capitalism.  We have commandeered its engine even though this engine is increasingly being obscured.  We are caught up in a movement away from its fundamental essence.  We have engineered an economic model where interest rates, monetary stimulus and increasingly de facto monetisation of government debt are accommodating the natural tendencies towards instability.  Issues such as a slowdown in productivity growth, declining population growth and ultimately declining populations should not in and of themselves cause the engine itself to fragment; I have discussed this before.   But, misidentification of changes in trend growth due to either changes in these key dynamics and issues of transition have likely exacerbated the natural instabilities in economic relationships that comprise the frame.

We have been overly focussed on the simplest of parameters, that of of expenditure and its measure GDP.  To set a rate of growth you need to know an awful lot more about the beast and its dynamics than we currently know.

If we could identify the capitalist engine we would likely see it becoming an ever smaller part of a bloated and inefficient economic frame.  We have financially engineered consumerism in a world incapable of fully realising the capitalist model, an engineered consumerism that is in certain key markets no longer able to sustain itself at an organic economic level.   There are concerns that we have even reached the limits of the “abuse of the model” in its current form.  That may be, certainly with regard to income and wealth distribution, certainly with respect to the relationship between asset prices and gdp and certainly with respect to the ability of the financial system to cope with the many disconnects and especially the complex financial/liquidity/collateral/derivative/liquidity relationships that have arisen as the financial world has expanded relative to organic fundamentals of population, productivity and distribution of incomes.

The more we engineer, the less the structure is able to operate without its support and its flows: note increasing government debt, the drive towards negative interest rates, Peoples QE and the greater role of the state.   

Money creation, one seemingly unlimited resource has helped pry apart not only the machine but the economic models on which central bankers and academic economists have sough to manage the economic frame.  The financial crisis that reared its head in 2007 and its build up for many years prior would likely not have occurred in an efficient capitalist model with rationale agents making rational inter temporal decisions, but more so in a model that had resorted to excess asset focussed money supply growth. 

But we are here at this point in time and the capitalist model it seems cannot be successfully replicated in today’s engineered and misaligned world.   We have clearly been engineering an alternate model, but it is not clear just what this model is or what its boundaries and structures are intended to be.

The still ongoing crisis is complex and has many roots as discussed (increasing inequality, demographic headwinds. transition of developing economies) and many policies (low interest rates, QE) which though appearing to support growth ended up aggravating the imbalances.  The powers that be have either misunderstood the difference between the academic models and their application in reality or chose to take a calculated political risk to favour short term benefits over long term consequences.

We are left with an economic body that at an organic level might well be capable of supporting human life, but even here we have little definition of what an optimal life is in terms of functions and resources etc.   Whatever we are capable of at an organic level (and I do not have the space here to develop this thought) the complexity, imbalances and excess of the financial system is a barrier to its evolution.  

What are the essential characteristics of the capitalist model, what are its structural weaknesses, and what is the necessary balance between control and freedom of man and the machine?  Rather than attempting to understand its fault lines and limit their impact we have chosen to ignore them and accentuate their impact by encouraging the development of greater structural and financial imbalances.   What we have today is a badly  engineered construct, a capitalist model operating within a habitat prone to instability where that instability has been accommodated and leveraged. 

We are one shock away from a further final manipulation of the structure that may end up clearly demarcating the modern economic frame from its preferred model benchmark.  It is possible that Central Bank money supply creation, instead of merely being used to finance asset purchases and provide liquidity to the financial system, may start to be allocated directly towards investment projects and a greater role for the state in resource allocation. 

There are a number of takeaways from the current model: the first is that demand can be engineered (the banking system with new deposit creation has shown that) but that this increases the divergence between asset prices (debt and equity) and GDP growth, the second is that structure can itself be imposed (increasing state intervention growth), but to what degree is the question. 

There is clearly a limit to both manipulations.  The two concepts of structure/engineering no doubt change the nature of the economic model and its risks to a frame that is ultimately dependent on the flows of both, as all models are dependent on flows.   Many of those who propose unconventional monetary policy and aggressive fiscal overlay (imposing economic activity onto the current weakening frame) assume that the issues we are facing are a) of a temporary nature and b) that existing equilibrium models apply and hence all that needs to be done is to reinvigorate the structure.  I believe we need to reassess the models and the frame and the engine otherwise we risk more of the same and possibly worse.  Man’s relationship with the economic frame, the impact of the human habitat on that frame and the planet that host it all needs to be carefully considered.

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