Friday, November 15, 2013

COMMON KNOWLEDGE: Capitalism (part one)

"Corruption keeps us safe and warm. Corruption is why you and I are prancing around in here instead of fighting over scraps of meat out in the street."

Capitalism was the main target of Karl Marx' work. He believed it was a great evil that was responsible for all the ills in the world.  This viewpoint has spread even more since the collapse of the Soviet Union, growing more popular and mainstreamed than ever.
In 2008 when the housing market crashed and banking almost collapsed, capitalism was blamed for it.  Some have argued that capitalism has been tried and found wanting, and we've evolved past that to a better system.  In fact, people blame capitalism for pretty much everything: greed, racism, inequality, poverty, disease, war, and so on.
Capitalism, it is argued, is a violation of others because there's a limited amount of wealth and resources in the world, so if one man becomes wealthier, others must become poorer.  It is argued that the rich get rich by stealing from the poor.  It is argued that government is fairer than business, so it should control the economy and wealth.  Some say that capitalism desires anything but a free market, celebrating monopolies and promoting all powerful corporations without accountability.
There are many ways capitalism is criticized, and quite vigorously these days.  Even ten years ago, capitalism was generally viewed as a positive influence and something people should pursue in economics.  It is only very recently that the shift in culture has led many people to think its evil and responsible for all their woes.
Is there any validity to these concerns?  Is capitalism the evil that many claim?
To understand this, we have to really know what capitalism actually is and is not.  The basic definition of capitalism is "an economic and political system in which a country's trade and industry are controlled by private owners for profit, rather than by the state."  That's pretty much it.  Its the opposite of socialism which has the system in which the government is the primary force controlling the economy.  That's what the "free" in "free market" stands for: free of government interference.
In other words, we are under a socialist system in the United States in most areas.  No system is ever truly universal; even in Russia there were outposts of capitalism selling black market blue jeans and food at farms.  And even in America at the height of its capitalism in the late 1800s, the government regulated and interfered with the economy.
There is still vigorous capitalism in some parts of America.  Food stands run by farmers, for example, are virtually unregulated and directly deal between the producer and the consumer.  Much of internet commerce is free market.  If I sell my art on a website, the government doesn't get their cut and doesn't control what I sell or how I sell it.  You can tell which areas of the market are primarily capitalistic by what the government is targeting and trying to regulate. The best you can really expect is to have the great majority of the economy one system or another, not its entirety.
And in the United States, the greatest majority of the market is heavily impacted by, regulated by, and run by the federal and state governments.  This has been true for quite a while now, but that's something I'll get back to in a moment.
Capitalism is simply the concept that the market and the economy is best run by the people actually engaging in the market rather than bureaucrats and government officials.  That's really it.  And in America, capitalism used to be not just the presumed norm, but considered a very good thing.  In the movie Its A Wonderful Life, Jimmy Stewart's crusading hero George Baily is a banker.
These days capitalism has taken a serious hit in the eyes of the public because of the economic crash in 2008.  In fact, a recent Pew poll reports that 49% of Americans 18-29 years old have a positive view of socialism, while only 46% have positive views of capitalism.  When the banks suddenly fell apart just as Barack Obama's polling numbers were dropping, people blamed capitalism for it all.  And it seems to make sense.  The housing market was ridiculously inflated in what economists call a "bubble," and that bubble popped.  
Like the internet bubble before it in 2000, prices were far out of proportion to their actual value and what cannot last forever... didn't.  This was blamed on greed and rich people manipulating the market which was because of capitalism.  Look at what they were able to do because of the free market, now all these people are out of jobs!  And they got away with it because capitalism is all for the rich and protects corporations! 
So what's wrong with this analysis?  Almost everything.
To begin with, the housing market was in that shape because of government regulation and interference with the economy.  Because the federal government passed several bills and leaned on businesses to behave in certain ways, people took advantage of that to become very rich and drive up prices.  This is a pretty complex thing that I've written about in the past but here's a very quick and dirty summary:
The Community Reinvestment Act was passed by Jimmy Carter in 1977 to encourage lending institutions to minorities and poorer people in America, especially inner cities.  This would allow people to own homes and buy property more easily.  
However, banks were hesitant to take advantage of this because it would mean giving loans to people unlikely or unable to repay them, which is a bad investment.
The government responded in three ways: 
  1. The federal government passed legislation under Clinton that allowed banks to trade loans including "toxic" loans as if they were valuable (toxic loans are ones unlikely to be repaid).  That way they could be bundled with real loans and purchased by a larger banking organization as if they had real value.
  2. The federal government assured banks that they would back any toxic loans with the Fannie Mae/Freddie Mac corporations created to help minorities find housing and get other loans.
  3. The federal government began leaning on banks which refused to take risky or impossible to be repaid loans.
So, banks started giving loans out to poor people and people clearly unable to repay their debt, confident it wouldn't come back to bite them.  As a result, more and more people started buying more and more houses, and speculating on real estate and property became a hot market.  
Since more and more people were buying homes, it was profitable to build them and sell the built homes to speculators who had a reasonable expectation of sales.
And finally, a tax loophole allowed people to ignore big "capital gains" taxes that are an additional tax rate levied on people who make large amounts of money at once.  If they would immediately turn and put that money into real estate, they could avoid the capital gains tax hit.
The result: banks loaning money to people who cannot pay, people pushing the price of homes up more and more (because the buyers weren't paying with their own money anyway, just getting loans they coudn't hope to repay), and taxes incentivized investing in real estate.
Away went the balloon.  And eventually, the market crashed.  All those banks assured they would be covered weren't, and many were gobbled up by huge mega banks like Citi and Chase Manhattan who were bailed out by the government in a bipartisan vote, fearing total collapse of the economy.
Now look that over.  Knowing what you know about capitalism, how much of that is the fault of the free market?  There's a little bit: people buying and selling property as investments, but they were doing so because of government interference encouraging it to take place.  Tax laws and loaning regulations, government pressure, and legislation concerning banking were what brought this about.  In other words: not capitalism (market drives economy) but socialism (government drives economy).
This is not something that should be shrugged aside.  The collapse in banking was directly driven by government interference with the free market.  It took a long time for all the pieces to get into place and for the disaster to really unfold, and its a bit more complicated than the quick sketch I showed, but that's the essence of what took place.  This was not the result of capitalism, period.
This is not to say that no recessions can occur as a result of capitalism.  Capitalism by its nature causes a sine wave-like pattern in economic activity.  Over time there will be almost regular patterns of growth and boom and then down times.  That's a result of market corrections and giddiness in certain areas.  However, in history and in practical application, it has been shown that these ups and downs are shallower and less dramatic than those which result from socialism.  When the government interferes with the market, natural smoothing and limiting forces do not and cannot take effect.  The more the government interferes, the worse this effect becomes.  Inevitably, eventually, the artificial level of prices, pay, and production will come to an end, and when they do, they don't reduce over time due to lack of demand or market forces, but suddenly, with a horrible crash.
So Capitalism does lead to boom/bust cycles, but much gentler ones than socialism does because it is not hidden behind government manipulation and behind the scenes accounting.  When the bad times come, they come and go rather than crash and stay like the present economy or in the Great Depression.
The Great Depression of the 20th century was a result of what people call "crony capitalism" gone amok.  Hugely rich and powerful men such as Rockefeller, J.P. Morgan, and so on got that way through using the federal government to help them get land for railroads, oil, and other ventures.  They used legislation and matching loans to purchase land and commodities and as a result became richer than is almost possible to conceive.  These guys were billionaires in the 19th century.
In addition, poor lending laws and action by the Federal Reserve allowed loans and investment in unprofitable areas seem profitable in a manner similar to the banking crisis described above.  And Herbert Hoover pushed through a huge tariff on goods imported into America, trying to encourage self-sufficiency and Americans buying American goods.  Almost immediately, every major nation on earth slapped the US with huge tariffs, killing trade.  Further, Hoover restricted money supply in an attempt to reduce the boom caused by widespread investment (the stock market grew rapidly), and this made it so banks couldn't get money to people when they ran to get their cash out.  This caused banks to collapse, making matters worse.  Finally, Hoover leaned on "short sellers" as unpatriotic and greedy, which prevented stocks from reaching a reasonable price.  
To put it simply, you have to be able to bet on the price going both ways in a stock market, or a given stock will never find its proper price level. Under Hooover (and later FDR), this activity virtually stopped, and nobody was certain whether the price levels on the market were accurate or not.  Trust eroded, and a collapse was set to take place.
Again: capitalism to blame?  Or government interference?  Remember, private markets doing business is not what defines capitalism.  They always will do business, whether under a totally socialist system or not.  What defines the system is who controls the economy, not whether businesses are involved at any level or not.  This is a very common misunderstanding, and often why people blame capitalism for what socialism caused: businesses did it, see they were involved!
That's enough for now, I will cover more capitalism myths in a future post.  There are a lot.
*For more on how the ACA and investment laws caused the housing crash, read this former post by me.
*This is part of the Common Knowledge series: things we know that ain't so.


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