The big question in the financial press last week—before the Fed’s bold moves—was 25 or 50 basis points, that is, should the central bank reduce the federal funds rate to 5.00% or 4.75%?  The lower figure would have to be accompanied by a statement suggesting the Fed’s willingness to do more if the economy falters, everybody said, because traders had already incorporated some measure of rate reduction into their calculations on the near term. 

The higher figure would have to be the last word, everybody said, because the resurgence of inflation already appears on the economic horizon—the fall of the dollar and the slowdown in the pace of globalization due to lower consumer spending by Americans will combine, it seems, to raise the price of imports—and the Fed can’t retain its legitimacy unless it vows, constantly, to fight inflation. 

Or can it?  Martin Feldstein, of all people—he’s the Harvard/NBER economist who fabricated the statistical correlation between high taxation and low investment rates which validated the supply-side argument back in the early 1980s—thinks we should discount the threat of inflation and address the threat of recession.  He’s worried that the global economy is at risk because the mortgage market debacle and its unruly offspring will reduce consumer confidence and spending in the US.    

Again, so much for the supply side of town.  Reality has a new address in the Age of Turbulence.  (See www.kc.frb.org)

The larger question behind all the anxious hand-wringing and rigorous prognostication is, what effect can the Fed’s decision on interest rates have?  If nobody’s borrowing even if the loan costs next to nothing, the financial system, both public and private, becomes a spectator in the stadium of the “real economy,” no matter how much liquidity it might provide. 

Turn that around.  If everybody’s borrowing because the loan costs next to nothing, the financial system, both public and private, becomes an accomplice in the crime of speculation, no matter how much risk it might try to displace downstream (down there on Main Street).

The answer to the larger question of the Fed’s effectiveness depends on another, and it sounds like an awkward translation of habeus corpus: whose body is borrowing, and when?  Everybody—that would be us consumers—borrowed like mad over the last fifteen years, and our “household deficits” compensated for the atrophy of private investment, thus fueling economic growth. 

By Martin Wolf’s estimate, the difference between consumer incomes and spending grew so rapidly in these years that by 2006, the aggregate financialdeficit of US households was equivalent to 4 percent of Gross Domestic Product: “The recent household deficit more than offset the persistent financial surplus [Ben Bernanke’s ‘saving glut’] in the business sector.  For a period of six years—the longest since the Second World War—US business invested less than its retained earnings.”  (Translation: robust growth was financed by consumer debt in the absence of investment.)

Consumers/households were borrowing on this astonishing scale because it was cheap, but also because they had to borrow if they wanted to make ends meet—that is, if they wanted to pay the rent (this would include the mortgage), or send the kid to school, or replace the car, or, yes, take that trip, buy that dress . . . .  Every choice entails a moral hazard; but if you can’t inhabit an acceptable future unless you finance it, you hedge your bets and you borrow against it. 

Meanwhile, after 2001, private-sector companies and corporations weren’t borrowing because they didn’t have to.  Surplus capital had become the rule.  As the Wolfman puts it: “Businesses had become net sources, not users, of finance.”

The same thing happened in the late-1920s.  Non-financial companies and corporations became active lenders in the call-loan sector of the stock market (to the tune of $6.6 billion by 1929), even as they opened time (not demand) deposits in the big banks.  They had nothing better to do with their profits—there was no place else to put the money. 

That is why the Fed cannot be blamed for causing or prolonging the Great Depression.  Milton Friedman’s disciples still believe that the central bank unwittingly raised real interest rates after 1929, thus enforcing a massive financial crisis (hence their adherence to automatic adjustments to money supply, not policy decisions made by human beings).  In fact, real interest rates were falling by 1932—they were negative by 1934—and nobody was borrowing, or investing, because they didn’t have to, or want to.  In fact, the Fed and the Reconstruction Finance Corporation, which Hoover invented in 1932 as a kind of super-ego for the hapless financial system, had already become spectators in the stadium of the “real economy,” where liquidity was not the problem.

Why?  Why so much surplus capital that there was no place to put it except in the first, and then the last, available receptacle for excess savings?  Why then, why now?

The short answer is disaccumulation, an unwieldy word, to be sure, but a productive concept, both coined by historian Martin J. Sklar almost forty years ago, in a fugitive piece published for SDS by Radical America (May-June 1969, pp. 1-41), revised and published in 1992 as part of Sklar’s essay collection, The United States as a Developing Country.

Economists like Wassily Leontief, Kenneth Kurihara, and Harold Vatter had been edging for years toward the startling ideas that Sklar laid out in this unlikely underground venue.  But his novel use of Marx and his intellectual purposes in advertising that usage gave the piece an enduring purchase on the imagination of the late New Left, even unto a citation in Fredric Jameson’s Political Unconscious (1981).  See Howard Brick’s new book, Transcending Capitalism (2007), for another distant echo.

The long answer to the “why” question is boring in the short run.  It gets pretty interesting, however, as we get closer to our own time.  So bear with me—that’s a verb, not an adjective.  Good students and obsessive readers who don’t want the Cliff Notes I am about to supply are herewith referred to my 1994 book, Pragmatism and the Political Economy of Cultural Revolution, Part I.  There they can suffer through a whole chapter on Marx’s reproduction schemes.  What was I thinking?

Ahem.  Accumulation of capital happens insofar as any increase in goods production and labor productivity—in a word, growth—requires net additions to the capital stock and the labor force, as in the period 1800-1920.  Disaccumulation happens when economic growth occurs without these additions, and indeed proceeds as a function of declining net investment, as in the period 1920-present.  There, I said it.

Declining net investment?  How so?  Gross investment is composed of replacement and maintenance of the existing capital stock, plus net additions to the capital stock.  Disaccumulation happens when the mere replacement and maintenance of that capital stock is sufficient to fuel economic growth on an astonishing scale.

Now, the implications are pretty weird.  On the one hand, human labor is extricated from the goods-productions process.  The horizon of socially necessary labor recedes, and the class position once enacted by the industrial proletariat becomes increasingly difficult to articulate.  So class consciousness gives way to other forms of identity in the 1920s and after.  On the other hand, the deferral of consumption, which presupposes increased savings, is no longer the condition of increased production—of growth.  Consumption now becomes the condition of growth because net investment becomes unnecessary. 

And so the deferral of gratification—saving for a rainy day—leads to economic crisis.  Uh oh.  As Stuart Chase exclaimed in 1934, “a whole moral fabric is thus rent and torn.”

The Great Depression of the 1930s was the first crisis caused by the disaccumulation of capital.  In the 1920s, consumer durables—automobiles, sure, but also radios, vacuum cleaners, refrigerators—were already the key to growth, the new “industrial blocs” that substituted for saving and thus offset declining net investment.  And already they were financed with the extraordinary novelty of consumer credit, or “installment debt,” which tripled in the decade (consumer debt on car payments meanwhile increased 500%, as individual savings fell by half).

At the same moment, in the industrial sector, capital costs were declining rapidly even as productivity was increasing sharply.  Just one example.  In oil refining, straight-run distillation of petroleum was replaced by “continuous thermal cracking” in the 1920s.  The new process quadrupled the yield of gasoline per barrel of crude, and yet cut refinery construction costs in half.

Similar innovation happened elsewhere in manufacturing, particularly in the automobile industry, with two results.  First, the replacement and maintenance of the existing capital stock were more than enough to increase productivity and output; in other words, net investment was unnecessary to fuel fantastic growth (64% increase in output for the decade).  Second, the labor force engaged in goods production—manufacturing, construction, transportation—declined absolutely, not relatively, by about 1 million. 

No wonder labor’s share of national income was falling precipitously as corporate profits soared after 1922 (an increase of 62%).  A shift to profits coincided with declining capital requirements in goods production—that is, with a shrinking field of remunerative outlets for domestic investment, and, for that matter, foreign investment (most of the Eurasian land mass was off limits to private enterprise in the 1920s due to revolutions, civil wars, radical social movements, or Herbert Hoover’s rulings at the Department of Commerce).  That is why these profits, this surplus capital, flooded the stock market, especially after 1926, and fed into “high-end” consumption as well.  

Meanwhile, the income required to buy the increasing output of “low-end” consumer durables—the income now required to sustain growth as such—was declining as a consequence of the same shift to profits.  That is why automobile sales and residential construction stalled after 1926.  And that is why Paul Krugman is wrong to claim, in 2007, that “America has never before experienced a disconnect between overall economic performance and the fortunes of workers as complete as the last four years.”  A very similar disconnect happened between 1926 and 1929.

It was a perfect storm.  The stock market bubble of the late-1920s and the financial crisis of 1929 were not random events unrelated to the “real economy.”  They were the immediate results of the disaccumulation of capital, which disallowed growth via increasing domestic investment and thus forced higher profits into the stock market— there was no place else to put it, unless you wanted to buy German municipal bonds or Peruvian consuls or Florida real estate, each a kind of risky foreign investment.  

Fast forward to our own time.  The housing bubble was the inevitable result of a savings glut that had no promising outlets except “securitized” (bundled) mortgages underwritten not by consumers’ income but by consumers’ debt.  The surplus capital accumulated by corporations could not, in other words, be converted into “investment” except as a bet on rising prices in the housing market, which presupposed miraculous increases either in consumers’ income or consumers’ debt.  There was no place else to put it.       

You might answer by saying that a distribution of national income undisturbed by any public policy will always have the same effect, and you would be right.  But the stock market bubble of the late 1920s was, in fact, enforced by public policy that favored private investment over consumption (Andrew Mellon’s tax cuts) just as the housing bubble of our own time was, in fact, enforced by public policy that favored private investment over consumption (George Bush’s tax cuts). 

My point is that so long as we assume that net investment out of private savings and corporate profits is the source of growth, we won’t be able to propose and defend the public policies we need.  Put it another way.  So long as we don’t understand how the disaccumulation of capital makes net investment a vestigial category, we’ll be inclined to bank on the profit motive and the private sector, maybe even to head for the supply side of town.  Or we’ll be inclined to regulate financial transactions at the micro level rather than shape the distribution of income at the macro level.

Here’s the programmatic syllogism.

If we know that growth is a function of declining net investment and increasing consumer expenditures, we will want public policy that favors wages over profits, consumption over saving.  Such policy need not take the form of legislative or executive fiat with respect to, say, windfall profits in the oil industry.  It could take the form of legislative or executive encouragement to unionization, as in the 1930s.  It could take the form of increased public investment in the nation’s infrastructure.  But the key to the success of such policy is the recognition that the production of value through work is not, and cannot be, the index of anyone’s income. 

To put it more plainly.  Either we learn how to detach (the receipt of) income from (the performance of) work, or we face financial/economic crises much more severe than the one the Fed is now trying to address.  Rising consumer debt can’t continue to finance growth in the US and in the larger world.  Only a different, more equitable distribution of income can—and that claim has international implications as well as domestic entailments.  On this even Alan Greenspan agrees with me: the “parallel” between real compensation and real productivity “has veered off course,” he says, and that accounts for profits higher than they should be in a world of “globalized competition.”  [FT 9/17/07, p. 8] 

But if the private sector can’t create enough jobs—and we know it can’t—and if the public sector can’t offset this shortfall, then perhaps we should understand “transfer payments” and “entitlements” via government(s) as the unintended yet effective prop of the income distribution we need to sustain growth.  Perhaps we should compare transfer payments to the consumer spending financed by federal deficits, ca. 1933-1937, which, inthe absence of private  investment, caused a precarious but real recovery (yes, a real recovery—by 1937, all the relevant measures except unemployment had regained the levels of 1929).

From 1959 to 1999, transfer payments—income received by households and individuals for which no contribution to current output of goods and services has been required—were the fastest growing component of income as such (10% annually), amounting, by 1999, to 20% of all labor income. 

So maybe we’ve already learned how to detach income from work.  Maybe we’ve been shedding our inhibitions, slouching toward Bethlehem, all these years.  Maybe we’ve been stumbling blindly toward Babylon, and the Fed, also eyeless in Gaza, has been with us the whole way.