The Scandal of Money: Why Wall Street Recovers but the Economy Never Does - George Gilder (2016)
Chapter 9. The Piketty-Turner Thesis
Egalitarians never seem to understand that promoting economic equality in theory means promoting resentments and polarization in practice, making everyone worse off.
—Thomas Sowell (2016)
The Left is right: current policies are exacerbating what it calls “inequality,” unjustly rewarding nonproductive wealth. When Manhattan flats go through the roof, nobody has learned anything but how to turn his home into an ATM for as long as the boom lasts. Wall Street and Washington working together are forcing Silicon Valley to play the unicorn game and Main Street to face foreclosure and stagnation.
Where the Left goes wrong is in diagnosing the cause and therefore understanding the cure. Across the Atlantic, in France and the United Kingdom, influential people have noticed the hypertrophy of finance and called for a new economic theory. Several candidates offer policy breakthroughs intended to be as far reaching as the New Deal that supposedly ended the Great Depression.
We have already met the Frenchman Thomas Piketty, that cherubic scourge of wealth, bearing credentials from Harvard and MIT, electrifying the crowds with Capital in the Twenty-First Century and its new “laws of capitalism.”1 Piketty warns that a society that stops growing will grow fat on finance and real estate. The accumulated overhang of capital and inheritance will overwhelm the future as entrepreneurs become mere rentiers of old wealth.
From the early 1970s to the 2000s, as economic growth declined, financial obesity became increasingly evident. Combined financial assets and liabilities in advanced economies rose from levels of four or five times national income to today’s level of ten to fifteen times national income in the United States, Japan, and France and twenty times national income in the United Kingdom, the world financial center. Following Piketty’s paradigm faithfully, accompanying this tumescence of finance—the harvest of what I call “hypertrophy”2—was sluggish growth and increased inequality.
Piketty might be surprised to find that many American conservatives agree with his analysis. If growth collapses and money expands, the financial and real estate sectors of the economy will swell. Such an economy will find many avid critics on all sides of the political spectrum.
Following in Piketty’s footsteps is Lord Adair Turner, who in 2008, at the height of the financial crisis, became the chairman of the Financial Services Authority, which regulates British banks. In 2015 he assumed the chairmanship of London’s Institute for New Economic Thinking (INET) and surpassed Piketty with a compelling tract, Between Debt and the Devil, based on the same trends and similar formulae.3 Both Piketty and Turner align themselves with the thinking of the American Nobel laureates Paul Krugman and Joseph Stiglitz, who contend that “the price of inequality” is slow growth and secular stagnation.4 They have that backward: inevitable effects of government policies that guarantee secular stagnation are inequality and the unjust enrichment of the already well-to-do, who can afford to buy influence and preference from the state.
Brooding over this hothouse efflorescence of “new economic thinking” is George Soros, the cerebral billionaire and disciple (from the left) of the philosopher Karl Popper. (From the right, I uphold Popperian empiricism as a key reason for the epistemic success of capitalism.) Soros expounds a theory of “market reflexivity,” according to which economic results stem less from fixed “facts” and fundamentals than from the interplay of investors’ opinions and strategies, which, in complex feedback loops, determine the facts and fundamentals.5 As a currency trader supreme, Soros is accurately describing the market that he has mastered. Partly bankrolling both Piketty’s and Turner’s work, Soros cofounded INET and has lauded Between Debt and the Devil as “the most penetrating analysis . . . to appear since the crash of 2008.” I may even agree with him on that.
In an unusual Right-Left consensus on our economic predicament, Turner reaches most of the same conclusions that Piketty does. Documenting the hypertrophy of finance, Turner’s book begins, “For many decades before the 2007–2008 crisis, finance got bigger relative to the real economy. Its share of the U.S. and UK economies tripled between 1950 and the 2000s. Stock-market turnover increased dramatically as a percentage of GDP. On average across advanced economies private-sector debt increased from 50 percent of national income in 1950 to 170 percent in 2006. . . . From 1980 on, the growth was turbocharged by the financial innovations of securitization and derivatives; by 2008 there were $400 trillion of derivative contracts outstanding.”6
Like Piketty, Turner invokes the insights of Henry George, who more than a century ago described in Progress and Poverty the tendency of wealth to congeal around scarce urban acreage.7 Drilling in on the fundamental problem, Turner asserts, “At the core of financial instability lies the interaction between the potentially limitless supply of bank credit and the highly inelastic supply of real estate and locationally specific land. . . . [R]ising real estate and land prices have been the predominant and inevitable driver of the increase in wealth-to-income ratios that Thomas Piketty has documented. . . . Credit and real estate price cycles, as a result, have been not just part of the story of financial instability [and inequality] . . . they are close to the whole story.”8
As an explanation for the current migration of money to real estate, Turner cites the radical low capital-intensity of “winner-take-all” information and communications technologies. With a near-zero marginal cost of production of new units of software or bandwidth, relatively small investments of capital yield ever-higher returns. The persons earning this bounty tend to invest it in the only large available sector that can absorb this money, namely real estate. In addition, Turner and Piketty contend, investment in scarce real estate is a function of increasing wealth and is thus both a source and a result of increasing inequality.
Real estate is also central to the net worth of the middle class. The Great Recession was made possible by the mobilization of most of the governments and associated banks of East and West in a mad rush to pump money into securitized mortgages on the margins of the middle class and below. Inequality in a top-heavy, slow-growing economy inspired a drive to substitute credit for real income and wealth. The result was a huge overhang of debt in the middle class and a swelling of assets at the top.
As a remedy for these disorders, Piketty would impose a progressive annual tax on capital. By a static analysis, such a tax might reduce the yield of capital to the rate of GDP expansion and thus eliminate the bias toward top-heavy accumulation by elites. Upholding the secular stagnation theory of permanent growth slowdown, he naturally focuses on depressing the return to capital. Taking money from the rich and giving it to government might seem to address “inequality.” But by putting capital into the hands of the least productive users of it—politicians—he would aggravate the very stagnation he warns against.
Turner and Piketty both urge an array of global wealth taxes as high as 10 percent and new marginal income-tax rates as high as 80 percent. They also call for new regulatory regimes for alternative energy and new capital controls. Turner advocates 30 to 40 percent reserve requirements for banks, regulations on “shadow banking” derivatives and securities, restrictions on international capital movements, and a global regime of trade rules. Since they believe the Great Recession had many causes, they marshal many regulatory tools to combat it and prevent its recurrence. Because they diagnose the problem as “inequality” rather than “stagnation,” they propose mechanical and accounting solutions that do not address what real people care about and what affects our well-being: opportunity, creativity, and growth.
Reflecting an accountant-economist’s vision of global equilibrium, this regulatory regime would in effect require every country to maintain a balance between production and consumption, imports and exports. No major export-led growth would be permitted in emerging nations like China, no specialization in venture capital and investment in advanced economies, no exemption from the worldwide web of welfare safety nets that spur consumption, no inequality in the winner-take-all global technology race, and no flow of investment capital to low-tax regimes, or real estate sumps.
Unlike Piketty, Turner spurns “secular stagnation.” He wants the world economy to return to the higher economic growth rates of the past, and he thinks he knows how it can be done. But Turner’s mistake is to assume, as some conservative monetarists do, that the government manipulation of monopoly money is a key to economic growth. A devout believer in the power of money, Turner wants central banks to counteract the existing overhang of private credit with the issuance of new money in any volumes needed to maintain “adequate levels of nominal demand.” Within an overall regime of inflation controls and cautions, Turner believes, government money creation is more favorable to growth than is private money creation through fractional reserve banking.
To Turner, money creation is a boundless abundance (“a potentially limitless supply,” to quote Milton Friedman), whether the credit is created by private banks or “printed” by the central bank. Turner prefers central bank money because it can be steered away from real estate and other existing assets into new assets. He favors government infrastructure, education, healthcare, technology, and other public benefits. In the quest for increased nominal demand, central banks can always create deposits at will and over the course of time can provide any needed amount. Inflation seems a remote threat in an epoch of near-zero interest rates and collapsing commodity prices.
Nonetheless, Turner correctly warns that real estate by its very nature is scarce. If the private banking system were permitted to generate credit at will, it would flow toward urban land, the price of which would be bid up vertiginously in the overflow of wealth from the new information economy. He shares the skepticism of Austrian economists about fractional reserve banking, whereby financial institutions can multiply deposits into cataracts of money and debt. Thus he prefers high reserve requirements and restrictions on international capital flows.
What insight does our new information theory of money give us into these prescriptions? In the new theory, the Turner-Piketty thesis rests on the triad of infinite time, finite space, and infinite information. As proxies for the finitude of space, choice urban and agricultural land absorbs excess demand stemming from the limitless expandability of the money supply.
The indefinite expansion of the money supply, however, is possible only to the degree money is freed from the constraints of time under a zero-interest-rate policy. Without any reliable metric or constraint, the nominal “money supply” can indeed serve as an inescapable abundance. But real money, whether gold or its digital equivalents, is founded on the scarcity of time. Time in practice is always finite, and money that reflects that finitude will limit the spiral of bidding for existing assets such as real estate. Mind—knowledge and information—may be ultimately infinite, as boundless as imagination, but in practice human creativity is bounded by time (money).
Although Turner believes that the remedy for capitalist excesses is strict and relentless regulation, the current excesses spring from regulations on all sides. Fostering runaway credit are banks and other financial institutions with government guarantees under Dodd-Frank, access to central bank discount windows, federal deposit insurance, and limited liability. Then the rules push banks toward real estate through near-zero interest rates on debt, through guarantees from Fannie Mae, Freddie Mac, and the Federal Housing Administration, through insurance from the Federal Deposit Insurance Corporation (FDIC), through bans on “red lines” and credit disciplines. Capping it all off is tax deductibility for mortgage interest and $500,000 family home exemptions from capital gains taxes.
The self-referential loops of limitless money creation are the fundamental problem. Without reconnecting money to the reality of scarce time, no regulatory regime is going to work.
If the ultimate source of the value of money is the scarcity of time, what happens when central banks and governments eclipse the cost of time by spurning every settled measure for money—from gold to interest income? It seems that money migrates to the residual scarcity beyond time, land. The cost of space—represented by select urban real estate and agricultural land and the commodities that they support—goes through the roof.
Since even central banks cannot rescind the law of gravity, what goes through the roof ultimately returns to the ground. This is the well-known cycle of real estate boom and bust, exacerbated in recent years by compulsive securitization of mortgages. With unmoored money, unlinked to time, markets follow what engineers call a “hunting oscillation,” gyrating spastically.
From Japan to Iceland, from Florida to Spain, a world of unmetered money has seen a twenty-first-century retreat from productive investment and a plunge into real estate and its finance. When money has no reliable metric but what it can buy, it migrates toward the visible and the palpable—an economy of now. A focus on existing assets leads to a shrinkage of investment horizons, a doldrums of growth, and an overhang of debt, marked by growing inequality and declining productivity.
The securitization of real estate does not even lead to more and better housing in response to market demands for shelter. A financial learning curve does not produce a learning curve in the construction of cheap housing. Driving information out of actual housing markets, financialization produces large discrepancies between the pattern of shelter supplies and actual needs and demands. In cities such as San Francisco and New York, which undergo so-called real estate booms, these discrepancies make housing scarcer and even increase homelessness.
Unmoored money unleashes financial hypertrophy, a tumescence of banking and other economic domains that feed on volatility and leverage. After 1970 the financial industry nearly tripled its share of the U.S. economy, and private credit nearly tripled its share of advanced-country GDP.
One group, however, is necessarily left behind. Incarcerated in time are nonfinancial wage and salary earners, paid by the hour or month. These time-bound employees are the foundation of much of the middle class and the real economy. Having tracked productivity gains in the years following World War II, workers’ hourly wages plateaued after 1973, rising a total of only 8.9 percent in the years since, while productivity rose 243.6 percent. Harvesting most of the difference were the forces that could siphon the immeasurable sums of government money, capturing transfer payments and subsidies, banking and central banking loops and leverage, corporate mergers and buybacks, and real estate finance.
The information theory of money can explain the hypertrophy of finance, the migration of money to real estate, the gyration of markets, the imbalances of trade and capital movements, and the rise of inequality, all part of the continuing catalog of complaints of accountant-economists. Turner and Piketty are correct that banks have become parasitical shufflers of existing assets rather than productive investors in new projects. They are describing the shrinking of the horizons of investment and enterprise in an economy where money is freed from the constraints of time and entrepreneurs are shackled by governmental pettifoggery.
Bidding on existing assets, investors avoid the perils of creative long-term commitments. In a world where money has lost its meaning and investment is beclouded by capricious bureaucracy and government intervention, entrepreneurs seek ways to abate uncertainty. Rapid-fire investment and speculation take advantage of the volatility of all prices in the oceanic turbulence of currency trading. Flash boys develop strategies to deal with micro-regularities amid a random undulation rather than investing in long-term currents of creativity.
The Turner-Piketty thesis requires power to be centralized, money to be manipulated, and regulations to be expanded. But this approach is the root of the stagnation rather than the remedy for it.
What Turner and Piketty and their sponsor George Soros curiously fail to confront is the global ocean of currency trading, which is the alternative to money as a metric with secure roots in the constants of nature. These bold thinkers simply cannot conceive of real money as a measuring stick. They remain at sea, therefore, in a currency morass that all their policies would make still worse.