In recent months unexpected calls have emerged from unexpected sources questioning whether capitalism is even working any more in a world in which corporate profits refuse to drop leading to paltry wage gains and thus, lack of the all-important wage inflation. Most recently it was none other than Goldman who wrote in February that "we are always wary of guiding for mean reversion. But, if we are wrong and high margins manage to endure for the next few years (particularly when global demand growth is below trend), there are broader questions to be asked about the efficacy of capitalism."
Maybe Goldman should ask the Fed about its thoughts on mean reverting "capitalism" in a world in which creative destruction is no longer possible.
Over the weekend, it was Deutsche Bank's rather outspoken credit strategist Dominic Konstam who, in a post-script to a note in which he ominously warned that
the "worst kind of recession" may have already started (based on Friday's nonfarm payrolls report), goes on to conclude that the crisis facing the "developed" world is a far deeper one than just that of profits and demographics. It is a crisis of capitalism itself.
This is what he said.
The reason that inflation is the historical exception rather than the rule is because of the over-supply issue. Say's Law says that supply creates its own demand, but only until it doesn't! This truism created Keynes' theory to work off deficient demand. It also includes the logic of negative rates to reduce the attractiveness of profits into cash that is superior to "goods" that will lose their value if hoarded, i.e. profits not being reinvested in the business.
Capitalism can be successful for long periods when it can identify new sources of demand that run in tandem with the production possibilities frontier. Demographics and globalization have heretofore been key: a billion Chinese consumers need cars; a baby boomer generation became consumers in the ‘90s. However, now the developed world is old and getting older. China has grown too quickly and needs its own time out.
Capitalism has a crisis. If only this was a Fed problem or better yet a negative demand shock that could be easily reversed. As it is, it looks more like a line in the sand for profits. Productivity has been too weak for too long. Things will need to get worse before policy can become radically better. That may involve piling more debt from government onto existing debt, coupled with “helicopter money” elements to reduce some of the burden for existing debtors. It could involve a direct transfer away from profits and savers to workers and spenders via negative rates and wealth taxes that banks collect either way.
There is light at the end of the tunnel. But we have yet got to the right tunnel and probably won't until the US falls into a recession.
This is a bull flattener and with Europe and Japan where they are, raises the probability of more deeply negative rates – including in the US. A few more labor market prints will decide. The Fed will be lucky to raise rates again this year.
Then again it is not capitalism, but crony capitalism that has a crisis: after all, how can one call a world in which both China and the US actively bail out not only money losing companies but the very capital markets every time there is even a modest deviation from centrally-planned trendlines, capitalism?
Even so, if Konstam is right, the Fed - which has staked not only its credibility but its very existence on keeping the US stock market propped up and artificially inflated - has a big problem.