In 1983 I took a fellowship year as the journalist I was then to address my own ignorance about economics, both the theory and the practice of the "dismal science." I thought I would understand capital allocation (what do you do with the money you have?) by studying banks.
Prof. Bill White, who taught at the Harvard Business School and had written their textbook on capital markets, disabused me of the notion that banks themselves allocate capital.
"No,' he explained, "Capital is allocated through a host of other agents and agencies - consumers, businesses, governments, military spending policy, waging war, etc."
Years later came the crash of 2008. With it dawned the realization that banks - mostly investment banks, allowed by Congress to do what the post-depression Glass Steagall Act had forbidden them to do - had engineered the single largest mis-allocation of capital in human history. Let's use the number $2 Trillion. True, others were involved, but it could not have been accomplished without banks acting outside the public interest for the private gain of the few.
Now the United States stands on the brink of collapsing its own economy in the face of global competition, unsustainable domestic and public debt and with a leadership paralyzed by ideological conflict. Little wonder that a movement called "Occupy Wall Street" has sprung up and spread as people who lost life savings, homes and the prospect of continued employment - or getting their first job in an activity worthy of human energy - have sought to express their discontent.
Private economist Andy Xie, based in Shanghai, has written about the "grim statistics":
- nearly 10per cent of US households have lost homes to foreclosure since 2008;
- 28 per cent of homeowners with mortgages have negative equity;
- 25 million people who want to work are unemployed or underemployed;
- real median household income has fallen by 10 per cent since 2007.
-the average premium for the household of employer-sponsored health insurance has risen by 9 per cent this year - about 28 per cent of median household income.
I am currently running a scenario exercise in Germany for a European-based global company that wants to better understand the risks and potential reverberations of the sovereign debt crisis. What has emerged in two days is a strong view that recovery is NOT just around the corner, and the rest of the world is likely to be involved in the recession or deflation or even depression that could unfold. All this because governments have borrowed too much, consumers have overspent and banks have been more than willing to play and to promote the debt game, often through sophisticated financial engineering that is arguably unproductive, and possibly counterproductive in the extreme.
An economist here has laid out the alternative policy responses to massive indebtedness, and what history suggests. Germany tried to money-print its way out of debt in the 30s and hyperinflation ensued. The US followed an Austrian model and tried to let the "bad companies" fail so the "good companies" could be rewarded, but the failure of too many "bad" companies led to depression. Since 1990, Japan has pursued a "buying time" model in which the can is kicked down the road (as long as there is road) by government support. Japan, unlike the US, began its crisis with massive domestic savings (12 trillion yen at the time). Its economy languishes now in part because institutions that should fail are not allowed to.
President Obama has unveiled a tax-funded plan for infrastructure maintenance (necessary roads, bridges, school) as an economic stimulus that leaves something productive in its wake. Funded by taxes rather than debt, such efforts are shown historically to contribute a dollar to the economy for every dollar spent, and they do not leave higher levels of debt in their wake. (It should not require much economic training to understand that debt cannot be solved simply by more debt.)
It appears the increasingly rapid Republican ideologues, who would rather damage Obama than address the economic problems now, may get their way. This will be another form of "misallocating capital" because it will mean we are doing nothing to address our crisis except failing to act in one of the few ways that history and economic theory/practice suggest we should.
I so fondly remember the late Professor White, a brilliant and kindly man who devoted his life to teaching students about how capital can and should work - only to learn that it is easily mismanaged by the relatively few humans who are in a position to allocate it intelligently - for the good of the many.
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