Capitalism Never Fails

If Ford wanted to make more money, he had to produce more cars... better cars... and make them more efficiently. That’s how an honest capitalist economy works. You get by giving, not taking.

Thursday, May 23, 2024

Bill Bonner, writing today from Dublin, Ireland 

Economic power, measured on the basis of GDP calculated according to the current rules, is fictitious.  

— Emmanuel Todd 

We began this cogitation by wondering what was wrong with ‘the West.’ Even with 30 times more GDP firepower it still can’t win a war against Russia. 

Then we noted that economies can look good on paper — the Soviet Union, Nazi Germany — but actually be destroying wealth, rather than creating it.  

We’ve seen, too, that much of Wall Street’s activity — supposedly trading capital assets — is little more than reckless gambling in meme stocks, NFTs, cryptos, and even good companies where the price bears no relationship to the real value. That is, these are not real capital assets at all — but phantoms and frauds. And if you looked at the trading activity in numbers alone, you’d get a very false idea of how much America’s businesses are worth. 

Looking more closely, we began to wonder more broadly. How come we have to pass our bills onto our children — $35 trillion in government debt alone? How come the average guy hasn’t had a real salary increase in half a century? And in today’s news, Fortune: 

... a new American Airlines flight attendant will have a projected annual salary of $27,315 before incentives and taxes are collected. 

The union has also been calling out the low starting pay, which for a single-income household, meets the qualification criteria for the federal Supplemental Nutrition Assistance Program (SNAP), or food-stamp benefits, in several states including Massachusetts and New York.    

Is capitalism failing? 

If we had a nickel for every time an economist proposed that “capitalism has failed,” we’d have to reinforce the floor joists. Capitalism never fails. It just adapts to whatever restrictions and circumstances we foolishly impose on it.  

In the economy of Henry Ford, the US was a freer, ‘more capitalist’ nation. It respected the three things that make capitalism’s win-win deals possible — property rights, enforceable contracts, and real money (backed by gold). 

Today’s economy still has property rights, and contracts are still enforceable in government courts, though capitalism today is subject to much more meddling and intervention today than it was a hundred years ago.  

Credit Money

The big difference is that today’s economy functions on credit, not on real money (cash). The change occurred on a now-familiar day, August 15, 1971. Thenceforth, foreign governments could no longer ‘settle up’ with the US by trading dollars for gold. 

The change was scarcely noticed. Even today, more people remember who won the 1971 world series — the Pirates — than the switcheroo that distorted the whole world’s money system.  

Henry Ford got rich by making something people wanted. No government subsidies were needed. No vast “industrial transition” was announced. No grants given. No tax breaks. No program to set up filling stations all across the nation.  

Ford sold his cars at a profit. And he increased his workers’ wages, in real money, backed by gold. 

If Ford wanted to make more money, he had to produce more cars... better cars... and make them more efficiently. That’s how an honest capitalist economy works. You get by giving, not taking. 

And today, yes, there are still a few genuine capitalists around. Elon Musk, for example, who is said to ‘sleep on the factory floor’ from time to time. And our new neighbor in Ireland, James Dyson, personally oversees the development and manufacture of hair dryers, vacuum cleaners and so forth. 

Most would-be billionaires, however, head not for the real economy of things, but for the financialized fantasies of Wall Street. They set up hedge funds... or go into venture capital... or do mergers and acquisitions; their hearts may be sooty, but their hands are clean.  

Why Wall Street? Because that’s where the new credit-based money is. In Henry Ford’s day, credit came from savings... and savings came from work. You had to earn it — by creating more real GDP — before you could save it. You couldn’t just create new money or new savings “out of thin air.” Because, ultimately, you had to square up with gold.  

But all that changed in 1971. Today, the big banks just borrow credit money from the Fed — often below the level of consumer price inflation. Thus, did the US begin another Misguided Economic Experiment... and another one that was destined to fail.  

The new money system was based on an illusion — that the ‘credit’ provided by the feds was every bit as good as old-fashioned savings. That led to another, even more dangerous illusion, that the Fed could increase the amount of credit available as much as it wanted... and that it, rather than willing buyers and sellers, should determine interest rates. Naturally, they tended towards lower rates, not higher ones. 

Donald Trump is a “low-interest rate guy” for a reason; that’s the way you make money in a fake money system. You borrow cheap, gamble on ‘assets’ (such as New York property) and, then based on the inflated values of your collateral assets, you’re able to borrow even more.  

After 1971, activity (GDP) continued. But the new credit money and artificially low interest rates made it possible to buy things that didn’t really contribute to the nation’s wealth. The feds’ debt, for example, memorializes $35 trillion worth of spending. Every penny of it was recorded in the GDP. But like the Nazi’s bombs... or the Soviet’s soap... .most of what it bought was fake, worthless or transitory. 

​​So too, much of the public’s $65 trillion in debt — all registered as GDP — was misspent. That is, the EZ credit made it possible for consumers and businesses to buy things they didn’t really need with money they didn’t really have. ​ 

But wait. The hamburger, eaten in 1995, and now recalled in monthly credit card payments, was real. It was consumed. It was enjoyed. Was it ‘fictitious’? 

No. But the GDP boost it gave was only half the story. That which credit giveth, repayment, default or inflation must taketh away. When the bill is finally paid, GDP should be reduced by a like amount (as money is taken out of the consumer economy to repay the loan). So, as long as debt is growing (with unpaid bills)... it gives us a false sense of real GDP. 

It is as if you bought your neighbor’s car. GDP would go up. But later, suppose you returned the car and got your money back. Economically, it was a roundtrip to nowhere. No real increase in output. GDP recorded the sale as a plus... but not the repayment as a minus. ChatGPT explains: 

United States Gross Domestic Product (GDP) does not include debt repayment. GDP measures the total value of all goods and services produced within a country over a specific period, typically a year or a quarter. It includes consumer spending, business investments, government spending, and net exports (exports minus imports). 

In other words, GDP only reflects half the transaction! 

Now, imagine that you borrowed the money to buy the car... and kept it. But still not paid for. GDP shows a ‘fictitious’ gain. It is ‘fictitious’ because there is an equal and opposite reduction to output still unrecorded. 

Total US debt — now reaching $100 trillion — represents increases to output that still haven’t been paid for. How much of that is bogus GDP? Impossible to say. Some of that will be repaid. But the traditional relationship of debt/GDP is 1.4 to 1. So, the US should only have about $40 trillion of debt. Much of the rest is probably unpayable... about $60 trillion of phantom GDP, waiting to make the final leg of the roundtrip to nowhere. 

Hang on to your hat. It could be a wild ride. 

Regards, 

Bill Bonner