How Monopolies Broke the Federal Reserve

(BIG issue 8-13-2019)


Welcome to Big, a newsletter about the politics of monopoly. If you’d like to sign up, you can do so here. Or just read on…

Today I’m going to offer some speculative thoughts on the relationship between monetary policy and monopolization. I’m a bit suspicious going into depth in finance, because the politics of money creation is a murky world of extremely confident lunatics. Still, with negative interest rates creeping across much of the world, I should probably say something.

Also, the regional Fed branches are luxurious. I’ve been in the New York Federal Reserve once, their cafeteria has an entire table just for cakes, and they have gold frames for flat-screen TVs with CNBC playing.

But first…


Three Years of Misery Inside Google, the Happiest Company in Silicon Valley (Wired)

How YouTube Radicalized Brazil (New York Times)

Silicon Valley’s Giants Look More Entrenched than Ever Before (The Economist)

‘Kochland’ Measures the Reach of a Politically Influential Corporate Giant (New York Times) Kochland is an important book, a beautifully written and reported story of the rise of Charles Koch by a great business journalist, Chris Leonard. My impression after reading the book is how similar Amazon and Koch Industries really are in terms of their business models, though they operated in different swaths of the economy.

Incidentally, I’m excited for a book by Binyamin Applebaum coming out next month called The Economists' Hour: False Prophets, Free Markets, and the Fracture of Society on how economists took power in the 1970s.

10% Tariffs Were Manageable. At 25%, Businesses Are Squirming (Wall Street Journal) Importers are doing everything they can to avoid having to do the work of making things. China is the factory of the world, and increasingly has market power in production.

SoftBank ‘operating group’ to forge alliances between its start-ups (FT) In the late 1960s, inefficient conglomerate theories around synergies and management brainpower masked accounting games by financiers toying with companies. I bring this up for no reason at all. There are no analogies.

And now…

How Monopolies Broke the Federal Reserve

Former Fed Chair Janet Yellen, just before the 2016 election, gave an important speech about how economists don’t really know much about how finance and the economy intersect. Here’s what she said.

Extreme economic events have often challenged existing views of how the economy works and exposed shortcomings in the collective knowledge of economists. To give two well-known examples, both the Great Depression and the stagflation of the 1970s motivated new ways of thinking about economic phenomena. More recently, the financial crisis and its aftermath might well prove to be a similar sort of turning point.

Her thesis is that the crisis revealed an intellectual gap at the heart of economic thinking. Yellen was correct in her observation. And there’s a signal that the blind central banking establishment has failed to to maintain any semblance of productive finance. All over the world, we’re starting to see negative interest rates.

Negative interest rates are a signal something is very wrong with finance, and the broader economy. Normally when you put money into a bank account, you get paid some interest on your savings. This is because a bank account is essentially a bank borrowing your money and using it to finance other loans that go into productive purposes like building factories. In return for your deposit, the bank gives you a cut of the action, usually a minimal interest rate. A government bond works the same way as a bank account, but it finances government spending and mostly bonds help finance savings for really large corporations and funds. Like a bank account, buying government bonds is a safe way to store assets, and get a little bit of a return.

But today, many bonds are paying negative or near-negative interest rates, which means that when you put money into government bonds, you lose money over time. Joe Weisenthal wrote up what is happening, using an agricultural metaphor of too much grain seeking too little storage.

In other words, to store money at a bank requires the existence of some other borrower who will pay the bank.  As such, just as you’ll pay more to store grain when grain is abundant and warehouse space is scarce, you have to pay more to hold money when savings are abundant but demand for borrowing is scarce.

This is the world we have today. Thanks to ever-increasing wealth concentration and meager growth across the developed world, you have some people sitting on incredible piles of cash and a shortage of people with robust opportunities to borrow and use that cash.

I’ll continue this metaphor to describe the job of the Federal Reserve. Let’s say we are an economy with only corn. Every year we eat 95% of the corn we grow and keep 5% of it as seed to plant. The Fed’s job is to make sure that the seed corn gets planted in a fairly reasonable manner. Zoom out to a more complex economy. That 95% is all the stuff we make and use, and that 5% is all the factories and whatnot we build so we can have more the next year. The Fed oversees getting our savings put into productive investment, and it uses the banking system/capital markets to do the planting (aka financing).

The Fed works through interest rates, which is to say, the price of money in markets where lenders and borrowers meet each other. Often you hear that the Fed raised or lowered ‘interest rates,’ but that’s not precisely accurate. There are many markets for interest rates, everything from credit cards to mortgages to junk bonds to an endless variety of swaps. The Fed changes interest rates in one particular market for money wholesalers (aka big banks). Most other money markets, like mortgages, credit cards, business lending, and so forth, are supposed to be referenced to the market in which the Fed operates, which is why the shorthand on the news is the Fed raised/lowered rates.

That’s the theory anyway. But the Fed’s tools, and those of most central banks, aren’t working like they should.

Very low or negative interest rates mean that investors can’t find any place to place their savings. Investors perceive there are no more factories to build, no distribution centers to create, no new energy systems to research, no more products to create. You can only stuff money under a mattress, and the price of mattresses is going up. Our financial system, in other words, is acting like we have no more social problems to profitably solve.

In a world with a looming climate crisis and endless poverty, it is extraordinarily weird to act like there is no way to profitably use capital. There is in fact an entire ideology behind this bizarre view; Democratic Presidential candidate Andrew Yang wants to cut every American a thousand dollar automatic monthly dividend, because automation has solved everything, created too much production. When asked about climate change in a debate, he actually said it’s too late and we must move to higher ground. Yet he also seems to believe that all problems he can identify have been solved by automation. Yang is a fringe candidate, but negative interest rates are the entire financial system agreeing with Yang’s view.

This problem, what economists sometimes call a ‘savings glut,’ has been with us in one form or another for decades. After the financial crisis, the problem of a lack of productive outlets for capital investment got so bad that important academics like Robert Gordon began arguing that we’ve simply invented everything important. His argument caught on in important circles.

For example:

Other thinkers, led by former Obama officials Jason Furman and Peter Orszag, argued that a small group of superstar firms have detached from the rest of the economy. Orszag and Furman do not conclude whether those firms have either managed to capture market power or figured out a special sauce whereby they are just more productive than everyone else in the economy. Perhaps Google is a monopolist, or perhaps Google search really was that much better than AltaVista, Yahoo!, Bing and so forth. In this framework, Orszag and Furman essentially agree with the Thomas Friedman-esque argument that globalization and technology has driven more productive companies to capture more power, and erode the share of output going to labor. McKinsey is even selling superstar firm gibberish to its clients.

So maybe that’s the problem. There’s nowhere to put money because either everything’s been invented, or because some firms are just better than everyone else.

Sorry, but I don’t buy it. If you give three billion people supercomputers in their pockets and connect those supercomputers into a massive real-time information grid, a few of them are going to think of useful things to do. Combined with advances in material sciences, biotechnology, genetics, optics, and just, well, more educated people than ever before, there are still amazing businesses to create. The argument against human capacity to innovate doesn’t make any sense, unless the people debating want to avoid discussing the key problem, which is power.

What is actually going on?

The most likely explanation for negative interest rates is far simpler. The economy has become a giant kill zone. In venture capital circles, the term “kill zone” has become quite popular to describe the phenomenon of having no places to profitably invest.

O’Reilly Media founder Tim O’Reilly talks of big tech companies “eating the ecosystem.” Others are talking about a “kill zone,” where new and innovative upstarts are throttled. For some startup founders, acquisition by a big company is the dream — they’re happy to walk away with a small fortune and move on to the next stage of their careers. But there’s a danger that big companies, being less emotionally invested in the companies they acquire, will leave them to wither on the vine.

And even more importantly, a kill zone can result not from acquisition, but from the threat of overwhelming competition. If founders believe that big companies will copy their innovations cheaply and compete them out of the market, they’ll never spend the time and effort to create those innovations in the first place.

Maybe what’s happening is that we can’t invest profitably, because there are monopolies everywhere you try to put money to work in the real economy.

Economists Simcha Barkai got to this dynamic in a paper he wrote in 2017. Barkai was interested in the decline in the amount of corporate output going to labor. He concluded this decline is not occurring because capital is getting a large share of income. Capital investment is going down even faster than labor share. There’s less spent on workers, and less than that spent on robots. So if labor share is down and capital share is down, what is up? Profits. The driver, Barkai found, is firm concentration is up across the American economy since 1985. This trend is more pronounced in higher concentration sectors, and less pronounced in lower concentration sectors.

Barkai doesn’t conclude that this change is policy driven, and doesn’t argue it’s a result of lax antitrust enforcement. But what his argument does imply is that large profits that cannot go into productive capital investment or to workers will instead go into government bonds, pushing interest rates for ‘safe assets’ down quite low, or even into negative territory. There’s just nothing to invest in, because you can’t put money into monopolistic markets and expect a return. The kill zone, in other words, is everywhere.

Investment in a Low Interest World

But this works from the other side as well. It’s not just that there’s no place to put money. Even though rates are low or negative, it’s very hard to actually borrow money and put it to work. How can I say this?

There seems to be enormous investment everywhere you look. Venture capital is pouring money into companies, and private equity is operating at a record clip. According to the FT funds this year are “set for their highest number of deals as record-low interest rates spur debt-fueled company buyouts.”

But private equity isn’t about putting money into productive areas of investment and compete with existing businesses. The business model of PE is to load up companies with debt, profit immensely if the market goes up, or walk away if the company fails. It’s basically speculating with other people’s money on entire companies, a heads I win tails you lose model.

And private equity isn’t the only business model out there engaged in speculation with low interest rates. Pouring of money into speculative endeavors has created entire industries based on money-losing froth, like Bird, WeWork, Uber, and Lyft. Basically, if you have a lot of capital, you can either stick in into large monopolies like Google, put it into ‘safe’ assets like negative interest bonds, use it to loot and speculate via PE, or just gamble and hope you get out before the bubble pops.

But guess who doesn’t have access to low or negative interest rates? Normal people and ordinary businesses. While powerful firms and individuals can borrow at record low interest rates, most firms and individuals cannot. Here’s an excellent chart from Axios of credit card interest rates, which is a key channel by which normal families in America borrow.

For some perspective, American families pay on average $1,150 in interest charges a year to credit card companies. (The other channels are student loans and auto loans, which have extremely high interest rates, and mortgages, which have low rates. There are also muni bonds for most localities, which is a heavily concentrated and corrupt channel of financing.)

In other words, there’s too much capital all over the world in a savings glut, so interest rates are low or negative. At the same time, the only people who can borrow this surfeit of capital at low rates are those who won’t put it to work in anything but speculative endeavors. Otherwise, borrowing costs are insanely high. The world of finance and monopoly is a small world, a club, and they’ve pulled up the ladder to make sure no one else can get in it.

For most of us, it’s a kill zone on the investment end, and a kill zone on the borrowing end.

The Broken Monetary Transmission Mechanism

All of this gets back to the Federal Reserve (and all other central banks, who think in very similar terms). What the chart on credit card interest rates shows is that the Fed’s attempt to move money into the economy doesn’t work anymore. The knobs and levers that translate interest rate changes into money being put to work in building things - the monetary transmission mechanism - has been severed.

The Fed can push dollars into the financial system or pull dollars out, but it does so through markets that only very powerful money wholesalers get access to. Those wholesalers aren’t lending into productive purposes, which is why rates are low or even negative. And when they do lend out to actual people, they do it into concentrated and corrupted markets with extremely high interest rates, like credit cards.

I wrote about this problem in 2012, in a paper called The Housing Crash and the End of American Citizenship, where I described how the foreclosure crisis snapped the spine of our financial system and social contract, in the process destroying the monetary transmission mechanism. I got this thesis from monetary economist Jane D’Arista, who has been noting for decades that the Fed’s monetary policy tools have weakened as financial power has consolidated into the hands of private financiers.

Professor Carolyn Sissoko, who has a powerful institutional view of monetary policy, is tracing the collapse of public power in depth in her series on the decline of Bretton Woods. But the bottom line is that public institutions, including the Fed, have been neutered in terms of the ability or willingness to wield power. They operate through private equity, hedge funds, large banks, and monopolies, or they don’t operate at all.

Economists are beginning to notice this problem. Let’s go back to Yellen’s 2016 speech. In her comments, she gently criticized macroeconomists, noting they work with models where all households and firms are treated as identical in terms of their ability to access and use capital. She said, “economists' understanding of how changes in fiscal and monetary policy affect the economy might also benefit from the recognition that households and firms are heterogeneous.”

In other words, she pointed out economists don’t see any differences between rich people and poor people, or any differences between small firms and big ones. In monetary economics models, Google gets the same borrowing terms and access to credit as a local bakery or a homeless guy in West Virginia. This is of course lunacy, but it’s very polite lunacy.

Why Conspiracy Theories, Socialism and Fascism Are Rising

For about half of my life, I believed in our institutional set-up as reasonably stable. But as the financial crisis hit, it became obvious that the language of our policymakers is seriously deluded. It’s insane that monetary economists have models that make the assumption that a homeless guy in West Virginia can borrow and invest on the same terms as J.P. Morgan or Google.

It’s similarly insane experts believe monopolies are simply better at what they do than other actors in the market, rather than recognizing that exploiting market power is a thing. Such models airbrushing out power lead to wildly insane misallocations of capital and power, mass suffering, and political chaos.

And that is what negative interest rates really show. We have a world where if you are close to power, if you are close to the financial system, you can get free capital with which you can gamble. You can monopolize, engage in lawless behavior, and strip-mine companies in horribly extractive ways. If you are not especially tacky, like if you don’t go all Martin Shkreli, you’ll get your mega-yacht. Meanwhile, if you are anyone else, you will have less and less economic and political sovereignty, and economists like Robert Gordon will tell us it’s because we’ve thought of all the ideas, or that we have no more problems to solve.

As we see with Boeing, the net effect of concentrating power among financiers is that planes fall out of the sky. The consequence for the rest of the population is increasing despair, and a willingness to believe in conspiracy theories that are no less true than what experts tell them about the world. Working class people increasingly want to just blow up the system, and why shouldn’t they? Why is Donald Trump fundamentally more dishonest than an economist whose model says that Goldman gets capital on the same terms as an ordinary family? That’s why, as in the 1930s, there are new ‘swamp things’ in politics, from socialism to fascism, coming into politics.

That’s what negative interest rates mean. It means that people with money see no more problems to solve. Most people think that’s a crazy way to see the world. And they are right.

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Matt Stoller