Surprise!

Remember 2008 and the financial crisis? Remember how the economy was slow for several years after that? They would show a graph of GDP rising on-trend, then suddenly falling below trend during the troubles, and then resuming a trend of increase, but at a lower level.

As you probably know, GDP was briefly good in 2021. People thought covid was over, and we felt pretty good about that.

The graph below shows GDI (Gross Domestic Income), which is just another measure of GDP:

Graph #1: Gross Domestic Income

Family Income by Source, 1988

From an article from 1995: Should We Ax the Capital Gains Tax? at the St Louis Fed:

The second column ("Capital") in the table shows the percentage of income from capital (as opposed to income from wages) as the Note below the table says.

Funny thing about that note. Right in the middle of it they change from explaining the table to making excuses for favorable treatment of the wealthy. It's blatant.

You'll find a similar midstream change in the third paragraph of the article:

• Paragraph 1 introduces the topic: "The battle over whether to cut the U.S. capital gains tax is raging again..." (This was from 1995, remember.)
  
  
• Paragraph 2 argues in favor: "On the one side are those who argue" in favor of the capital gains tax cut.
  
  
• Paragraph 3 starts out by saying "On the other side, however, are critics..." But the next sentence takes the proponents side, and it's all downhill from there.
  

Such writing is for people who already have their vested interest and their opinion in favor.

 

It wouldn't matter, except in the long run this is part of a battle over the continued existence of civilization.

The true meaning of "capital"

You might be interested in this page from CFI. 

I was going to quote two paragraphs, but the Terms of Use are, um, very corporate.

You still might find the page on capital interesting. But don't quote from it! Their "Terms of Use" page says something like they have the right to castrate your heirs if you do.

All that remains

Recently I said:

If debt was low again, really low, we would have money left over after paying the bills. No one would have to be demanding wage increases or raising prices.

To continue that thought: In the low-debt, low-financial-cost economy, people would have more income available to spend, and business would have more available for profits. I know, they say business profits are high already. But they're talking about a few big businesses, like Apple and Google. I'm talking about Mom-and-Pop shops. The ones you see on the local news every so often, going out of business, where the proprietor is crying on camera.

In the low-debt economy, the mom-and-pops would be doing better. Moms and dads and families would be doing better. Big businesses would probably be doing better, too.

But it's not magic. We need low debt to get costs down for people and for businesses. But we need something more as well: We need something to make people "feel" that the economy is better, to make people feel that things are good again. We need something like winning the second World War or putting covid behind us. But covid didn't work, did it.

Winning WWII gave people a jolt. People had jobs. People had money to spend. The jolt got the economy going. Then things were good for 20 years or more. The economy was good for 20 years or more.

Putting covid behind us gave us just one good year:

Graph #1: Annual Rate of Real GDP Growth, 1980-2021

2021 was the best year for GDP growth since Reagan's "Morning in America".

So maybe this leaves a lot to be desired. GDP is not the most satisfactory measure. And because of increasing inequality, the people who most need a good economy get the least benefit from it. And anyway, 2022 sucks, I know. I know.

But what happened? Why didn't the jolt work?

Well, it tried to work, but we still have too much debt. Too much financial cost. So instead of getting great growth, this time we got inflation. We got cost-push inflation. Prices went up because businesses were trying to cover their costs. But we will never cover our costs as long as the cost of finance keeps rising.

These days, people say there's no such thing as cost-push inflation. They say it, because if the money isn't there -- if the spending isn't there -- then you won't get the inflation. 

Yeah, but you won't get growth, either, if the spending isn't there. The economy just slows more. And there is still the "cost-push" to deal with: Cost pressure, arising from the cost of finance. 

And since finance continues to grow, the cost of finance continues to rise, and the cost pressure is unrelenting. And things get worse.

 

I don't like the term cost-push. The "cost-push inflation" concept implies that you cannot have cost-push pressures if you don't have inflation. But that is wrong. So I just talk about "cost pressure". Cost pressure can be relieved by inflation. But that is not the best plan, because inflation does not solve the cost pressure problem. Inflation is only a way to cope with the cost pressure problem, even as that problem continues to grow worse. That's what the "two percent target" was, a way to get a little growth by allowing a little inflation. Not the best solution.

To solve the cost pressure problem, we must first discover what creates the cost pressure.

Growing financial cost creates the cost pressure.

To solve the cost pressure problem caused by the growth of finance, we must first discover what is causing the growth of finance.

Economic policy promotes the growth of finance.

To solve the problem created by economic policy, we must make sure policymakers understand that the chain of causality begins with them. A lot of people think government is running the economy into the ground on purpose. I don't see it that way. I don't see how that could be. I think they just don't know how to fix the problem. But even if it is on purpose, we can probably get them to see that the cost of finance is a problem, not a solution.

Economic policy promotes the growth of finance, and has done so since the end of the second World War. At some point along the way, finance became too big and costly for our economy. We could no longer afford it. That's when things started to go wrong.

We could probably argue for the rest of our lives about when things started going wrong. That wouldn't be productive. We need to start replacing money-that-costs-interest with money-that-does-not-cost-interest. We have to reduce the cost of interest, but we still need enough money that the economy can function.

We can keep doing that, gradually, for a while. And we should start thinking about what level of debt would best promote economic growth. And thinking about proportions: how much of the total debt should be owed by government, and how much should be owed by the private sector. If we can fine-tune these two adjustments, the level and the proportions, we can make our economy unimaginably good. Unimaginably good.

Remember, borrowing money and spending it is good for growth, but paying the interest and repaying the principal are bad for growth. But there will be some level of debt and some balance between government share and private-sector share of debt that best promote price stability and economic growth.

To solve the problem created by economic policy, we must make policymakers understand the problem. All that remains is to convince them.

Where no output is produced, one sector's gain is another's loss

The profits of financial (nonproductive) corporate business are smaller than those of nonfinancial (productive) corporate business. At the end of 1951, the profits of finance were only 10% of nonfinancial profits. Until the mid-80s they were generally less than 20%. Financial profits ran about 30% of nonfinancial in the 1990s, between high peaks. And since 2010, between 30 and 40 percent. Financial business profits are less than nonfinancial business profits. But financial profits have been gaining on nonfinancial profits. 

To look at that gain I show financial profits (red) and nonfinancial profits (blue) as percent of GDP. I index both ratios to show them equal in the first quarter of 1952:

Graph #1: Financial (red) and Nonfinancial (blue) profits, relative to GDP
with both ratios indexed near the start for purposes of comparison.

The lines start out equal in 1952. But consider the early years, up to the late 1970s: Financial profits show a general uptrend. Nonfinancial profits show a mild downtrend. 

Indexing makes the graph exaggerate what I will say now, but what I say is still true: If the financial share of corporate profits held fast at the 1952 level, the financial profits above that level would instead have been the profits of nonfinancial corporations, or would have added to labor's share of income, or would have worked out as just plain lower prices, as financial costs fell as a share of productive sector costs. Any of these options would have been better than the way things actually turned out.

 

Nonfinancial profits on the graph show a mild downtrend. It looks mild to me. But when I google profit crisis of the 1970s the featured snippet says: 

In the 1970s, US capitalism suffered a legitimacy crisis as the economy was mired in high inflation, unemployment, and slower growth. The rate of profit had been decreasing since the late 1960s and by the mid-1970s Wall Street was in poor shape.

Clicking the link turned up "The Revenge of the Capitalist Class" by Thomas Volscho. Google's snippet came from the Abstract. Here's the next sentence:

Capitalists politically mobilized in the 1970s to restore the rate of profit and to restore power to economic elites...

In Financialization as symptom, Chris Dillow says:

"My generation of leftists ... was shaped by a crisis of non-financial capitalism – that of the 70s and early 80s... [L]et’s start with the crisis of the 70s. Profits were then being squeezed by wage militancy. Thatcher’s response to this was to weaken labour’s bargaining power by (inadvertently!) creating mass unemployment..."

He's right, except for the "wage militancy" part -- but that was Thatcher's error, not Dillow's. The actual cause of the profit crisis was the growth of financial cost, which increased the cost of the average transaction, increased financial profits, pushed the cost of living up, pushed nonfinancial business costs up, and pushed nonfinancial profits down. Dillow also says:

Financialization is the result of a shift away from low-profit activities in the real [nonfinancial] economy.

Early on, rising financial costs drove nonfinancial profits down until people noticed the problem. But their policy changes encouraged financialization and drove financial cost even higher. The graph shows it.

Bill Mitchell writes:

Rowthorn says that the mid-1970s crisis – which marked the end of the Keynesian period and the start of the neo-liberal period – was associated with a rising inflation but also an on-going profit squeeze due to declining productivity and increasing external competition for market share. The profit squeeze led to firms reducing their rate of investment (which reduced aggregate demand growth) which combined with harsh contractions in monetary and fiscal policy created the stagflation that bedeviled the world in the second half of the 1970s.

Since that time the world has been bedeviled by the solutions that were put into place.

And finance was growing the whole time

Graph #1: Household Debt as a Percent of Disposable Personal Income  1946-2021

We ("households") owed debt equaling about 20% of Disposable Personal Income (DPI) in 1946. That tripled to 60% by 1962. More than half our household income, by 1962.

The ratio ran flat from the mid-1960s to the early 1980s. Not by coincidence, Allan H. Meltzer puts the start of the so-called "Great Inflation" at 1965, and the end at 1984. Inflation increased DPI so rapidly that it made the ratio run flat all through those years, even though household debt was still going up.

After the Great Inflation, the ratio doubled from around 60% to more than 120%, just in time for the financial crisis. Most people who write about this stuff would say it was our own fault our debt went up. I say it was the fault of policy -- the economic policy that encouraged credit availability, encouraged credit use, discouraged repayment of debt by making interest payments tax-deductible and, according to Scott Sumner, by restricting wage growth.

Since the high point in 2007 the ratio has fallen to just below the 100% level, so that household debt is now about equal to DPI. But it is still way too high. You can tell because our economy still sucks.

If debt was low again, really low, we would have money left over after paying our bills. No one would have to be demanding wage increases or raising prices.

Cost pressure

If we have a "cost pressure" problem, it impacts the whole economy. The cost pressure works the way an oil crisis works -- (1) by creating a general inflation and (2) by slowing economic growth. But with cost pressure it is not necessarily the oil producing nations that benefit.

1. I think we have a cost pressure problem. I think this because we never really did stop the inflation. Oh, we slowed it, yes. But prices did not stabilize. Instead, policymakers quit trying to achieve "stable prices" and started trying to achieve "stable inflation" instead. Stable prices means zero inflation. Stable inflation (with a two percent target) means they shoot for two percent inflation every year.
   
   
2. I think we have a cost pressure problem. I think this because economic growth has been slowing for almost the whole time since the end of World War Two. Economists do acknowledge bits and pieces of the slowing, and try to explain it. But they certainly have not reversed it. The slowing continues. Pay does not keep up with prices, and it gets harder and harder to find a better job.
   

We have had inflation and slowing growth for many years. So I think we have a cost pressure problem.

The rapid growth of finance since the end of the second World War suggests that finance is the sector which benefited from the increasing cost pressure that we were living with. The rapid growth of finance suggests that the growing income received by finance is the growing cost that causes inflation and slows the growth of jobs and income in the general economy. 

Again, the growth of finance is responsible for the cost pressure, the inflation, and the slowing growth that we have been living with now for half a century and more. And finance was growing the whole time.