Review - What Went Wrong With Capitalism

Notes from a book that helped me understand better the problem of ever increasing regulations.

• The author in the Intro charges BJP along with Congress for continuing on the path of overpromising and under-delivering.

• He reminds that NaMo promised “minimum government, maximum governance” - but then went on to offer more freebies than Congress (pucca home with gas and electricity).

• The book’s main premise is debunking the idea that Ronald Reagan fulfilled his promise of shrinking the government.

• The author details how it infact grew then and has been growing ever since and Joe Biden enlarged it even more.

• He highlights how there is political and popular support among both camps to grow the government more to deal with any issues. Easy to see that the author fundamentally believes the government should be smaller in size and staying out of certain areas.

• Big government never went away.

• Another reason that capitalism doesn’t work (as alluded to in the title) : At the first sign of crisis - the government steps in and money is pumped into the system to stabilize it; rather than capitalism work and pick its winners and losers.

• Thus, “socializing” the risk to everyone - and the government. Extending safety net to poor, middle class and the rich.

• Hauser’s Law - empirical observation which suggests that there's a natural limit to how much the federal government can collect in taxes, regardless of the tax rate. Around 20%

• The RR era spawned a belief that deficits and debts do not matter, and the Republican solution to every problem is a tax cut. Similarly, Democrats would make the case of “more” spending on schools, health, public infra as an investment in the future.

• The Keynesian idea is that the government should run deficits in hard times to create jobs and surpluses in good times.

• This and the book I read last year (Lords of Easy Money) reiterates that it is the central bankers that stand between the world and the Great Depression.

• One severe criticism the author gives to the Biden admin is that they picked 3 winners (industry) in the economy, even when they claimed to not want to pick winners. They were in semiconductors, green technology and precious metals. As per the author, this is no different than how China decides which industries to pick from.

• One tidbit around Private Equity - I gathered from the book is that bigger the Private Equity firms get, bigger their insight and collection of data becomes. Because they have so many subsidiaries at different steps of the supply-chain of an industry that they can paint a picture of what is going on.

• Jefferson, one of the US founding fathers, believed that the government had to be small.

• But politicians and central bankers are now programmed to think that the Fed needs to do more in the times of crisis.

• The author reminds that when the Fed did not interfere in the 1930 depression that coincided with the highest productivity growth in US history.

• Paul Volcker showed toughness with the willingness to fight inflation in the 1980s. And it would not be repeated until 2022, when J Powell had to fight inflation, almost 40 years later.

• Paul Volcker then faced severe criticism and political pressure for his decision to increase interest rates (high teens) but stuck to his task.

• After Volcker’s victory over stubborn inflation, interest rates remained around 2% from 1992-2022.

• Ronald Reagan (RR) did cut the top tax brackets but then also introduced a bunch of other taxes like sales tax etc.

• In the 2000 US POTUS election, the last time the US had a surplus, the question in the debate was - How to spend the windfall (surplus)? Al Gore said - we will pay down the debt; HW Bush said - I’d return that money to the voters. Guess who won?

• Reagan did less to “reverse the course of government” than he had intended or gets credit for.

• Greenspan Put, later known as the Fed Put = Central Bank guarantee to minimize market pain in future crises i.e in market speak Fed would put a floor under the market prices.

• The author also blames a generous welfare program contributing to spending and deficits. He points out that the US ranks second in developed countries with 30% of GDP towards welfare. Surprising stat!

• It does not make sense to me personally - the Stanford online course on Poverty in America highlighted the need for more welfare, the public transit infra in the US is dismal. It implies that somewhere there is a lot of wastage.

• Author seems to be silent on what his objection is more public spending towards healthcare, and childcare. Will it not lead to more productivity? Perhaps, it is an ideological issue.

• To generate growth - government spending has continued at unprecedented levels backed by debt. Some money has gone towards productivity growth, and rest in speculative assets or corners.

• For advanced economies - fastest possible growth rate is 1 to 2%.

Impact of low interest rates (free money)

• Free money distorts and disorients the capitalist system.

• People make purchases and investments they normally would have dismissed as excessive/irrational in normal times.

• Free money inflates prices for stocks, bonds and other assets.

• Thus, free money leads to asset bubbles.

• After 9/11, low interest rates became permanent. What was something to be done only in a state of emergency, became a permanent feature.

• Fed started to make an asymmetric promise - To help if times get tough but to leave you alone when times are good.

• Fed technically does not order the Mint to print more money.

• But it creates money out of thin air.

• Fed’s purchasing agents in NY call their contacts at the 24 primary dealers in big banks like JP Morgan, Chase, GS and offer to buy their bonds. With 1 keystroke, money is deposited in the dealer’s account and money is created.

• Also, during the 2008-09 crisis and then in 2020, Fed bought so many 10 year Treasury bonds that it brought the bond’s yield down (because price went up and inverse relationship). Because of low yield, investors now had to look for more riskier assets.

• Ben Bernanke (Fed chair in 2008) did this to make Americans feel richer as their asset prices increased in value because the Fed was buying government bonds in bulk.

• Alan Greenspan (Fed chair) kept cutting interest rates even with low inflation thus fuelling the bubble.

• Since the Fed can move faster than the elected government - they have taken over the responsibility of rescuing an ailing economy.

• Based on the above, people do not pay enough attention to this transfer of power from the government to the central bank.

• In the 2020 crisis - the mandate was to err on the side of excess with respect to help.

• The U.S government issued more debt in the first 12 months of the pandemic than it had issued in the first two centuries (200 years) after its founding in 1776.

• Easy money has the households and corporations addicted to the rising asset prices, and made them intolerant of what once had been “healthy” market corrections.

• No elected politician can now dare take the “easy money” away and say the truth.

• Until DJT, debt (stimulus) was only used for recovery from wars, recessions but since then the mode has become “permanent stimulus” - stimulating growth due to massive tax cuts while racking up debt.

• Easy money leads to zombie companies.

• Zombie company = unprofitable company living on bank support or company earning too little to cover its interest payments for 3 years running.

• There is also a connection between zombie banks and zombie companies.

• Just because zombie companies survive - they make the otherwise healthy companies compete with them for resources.

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Ever growing regulations

• The author makes a good point that many people (smart) believe that we are living in the era of small government, when infact the data shows the opposite. It is because people think markets have been doing well, that means the government must have shrunk.

• Ronald Reagan’s era resulted in less full-time government employees but a lot more private contractors working for the government.

• Liberals view contractors as greedy corner cutters. Conservatives view public government employees as lazy incompetent. Regardless, of whether it is a full-time or a contractor working for the government - it’d impact spending and deficit in the same way.

• Since WWII ended, securities agencies in the US have now jumped to 18 from 3 before.

• The agency that performs security checks at the airports now has 60,000 employees.

• Incoming tourists to US airports now face 2-4 hour waits at immigration checks.

• Author claims above are the signs of a bloated bureaucracy?!!

• Code of Federal Regulations is now 180,000 pages as of 2023.

• U.S Congress tax code is 7000 pages long. And then IRS rules around it are 68,000 pages long.

• The U.S has more lawyers per capita than any other country partially due to the above.

• I am now able to appreciate the criticism of having too many regulations, and rules and a bloated bureaucracy much better.

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Privatization of Services

• Many European countries have private rail services, seaports, airports and postal service.

• Why should the US not do the same?

• Does it make sense to have bureaucrats who have, at best, a modest experience running a business - run a huge entity like a postal service, airport?

• Having the government run these entities is a factor towards big government.

• The only sectors the government has retreated are airlines and electric/water utilities.

• He defines a phenomenon “privatization by malign neglect”. Incases where the government is not allowed to sell an entity - the entity is ignored, languishes and loses value over time with significant decline in utility and benefit. This helps the private competitors and eventually this entity is sold off at a much lower rate.

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Countries where capitalism has been doing well

• Mixed capitalism, with a strong role of the state is the best option.

• Pure free-market ideas went away at the time of the Great Depression in the 1930s, the question before us is how to get the balance right between regulations and growth.

• Author lists 3 examples where capitalism has performed well - Switzerland (high income); Taiwan (medium income); and Vietnam (low income).

• At one point, the author mentions in relation to Taiwan - to become rich a country needs to make things and Taiwan excels here (semiconductor chips).

• Same thing Raghuram Rajan also suggested - move away from the service economy.

• Vietnam’s per capita income ($14,000 as of 2023) is higher than India’s ($10,000 as of 2023).

• Vietnam has gotten the balance right when it comes to building infrastructure and education. Test scores in Vietnam are higher than U.S and U.K.

Way forward

• Author reminds us that the top 2% in NYC pay 50% of the city’s taxes, perhaps hinting at the golden goose and egg fable?

• I like that he then quotes F. Hayek who said “road to serfdom is paved by government planners too sure of their economic science but with full support from citizens who are willing to forfeit the burden of making choices in favor of comforts of certainty”.

• Ruchir Sharma reminds us that the ever increasing deficit can become a turning point and lead to a decline. He gives the example of Greece, birthplace of democracy, now known as a parody of financial irresponsibility.

• Every global empire by virtue has the “world’s reserve currency” title - Portugal, Netherlands, France, Spain, England and USA.

• With being the “world’s reserve currency” you get some borrowing privileges. BUT, if you spend/live beyond your means - debt will accrue.

• He references Ernest Hemingway’s novel “The Sun Also Rises” - where Hemingway describes how one of the characters went bankrupt - “two ways, Gradually and then suddenly”.

• An economist then said “ the crisis takes a much longer time coming than you think, and then it happens much faster than you think.”

• Currently, the only argument made in favor of USD is that the competition to replace it is weak; not that USD has some merits to it.

• The U.S is the 2nd rank in developed countries after Portugal that owes a lot of debt to foreigners - showing how far old empires can fall.

• Brazil’s President Lula in 2023 said, “Every night I ask myself why all countries have to base their trade on dollars.”

• Author is critical of Bidenomics which made excess spending, regulation, bailouts for US companies and the world.