Policy Research in Macroeconomics

Vultures are Circling our Fragile Economy. We Must Not Let Them Feast.

Vultures are Circling our Fragile Economy. We Must Not Let Them Feast.

This article appeared on the Open Democracy site on 16 June 2020

On the weekend of 30 May Elon Musk – a billionaire with a net worth of $38billion – launched a rocket into space. This private venture was in contrast to President Kennedy’s ‘moonshot’ ambition of 1961-69 ­– one of the greatest mobilizations of public resources and manpower in U.S. history. Musk’s ostensible aim is to colonise Mars; but his ultimate purpose is to extract future rents from billionaires ferried into space, and from taxi services conveying public aerospace sector (NASA) astronauts to the International Space Station.

A discordant note was struck on the day of Musk’s ‘Starship’ launch. Hundreds of thousands of Americans ignored the event while they angrily protested the police killing of George Floyd in Minneapolis. No other event illuminated so vividly the huge gulf between ordinary Americans and a fabulously wealthy elite.

Elon Musk was not the only billionaire celebrating that weekend. American billionaires increased their wealth by $282 billion between 18 March and 10 April, when millions of citizens were in ‘lockdown’ to prevent the spread of the virus. This was an almost 10% gain, according to a recent report by the US Institute for Policy Studies (IPS). Over the same period 22 million Americans lost their jobs as the unemployment rate surged toward 15%.

Not all billionaires were so lucky. Richard Branson, a man who the Financial Times characterises as “a vastly rich, private jet-toting tax exile” and “the strange boy-racer of the Virgin Galactic space tourism fantasy­” – was in trouble. He was forced to plead for a taxpayer-backed bailout because of the grounding of his airline Virgin Atlantic by the pandemic. His plea was not warmly welcomed by a public aware his holding company is lodged in a disclosure-free tax haven in the British Virgin Islands.

Richard Branson has accumulated wealth almost effortlessly by renting out assets – his brand and various franchises. Like Elon Musk, these have invariably been acquired by borrowing. The users of his gyms, banks and airlines regularly fork out royalty payments to the vastly rich tax exile; payments channelled straight into the British Virgin Island tax haven.

Richard Branson belongs to the global economy’s dominant player – the rentiers.

The rise of the rentiers

Rentier capitalists make capital gains more or less effortlessly, at the expense of others. They do so by exploiting an existing asset – think of a London or New York property – and make money from ‘renters’ using that asset, or from re-selling the asset at a higher price.

Rentiers are distinct from traditional capitalists. The latter make money from investing in, and exploiting land and labour, to create a new asset or assets, from which they profit. Rentiers make capital gains, not by investing in land and labour, but by deriving rents from the ownership of existing assets.

Debt is a valuable asset (sovereign debt the most sought-after) and generates ‘rent’ in the form of interest – almost effortlessly. Interest as we all know, is subject to the well-known mathematical laws of simple and compound interest, and so can rise exponentially. Capital gains also tend to rise at exponential rates. Profits by contrast, can be volatile, rising or falling depending on local conditions relating to land and labour (in the broadest sense).

Governments, including the UK government have encouraged rentierism by lowering tax rates on capital gains. The standard capital gains tax rate is 20%. This compares with the 40% income tax rate on salaries of between £50,001 and £150,000.

The international financial system of capital mobility has been so structured as to grant rentiers like Richard Branson permission to move capital gains out of the country of origin, and into tax havens. Until changes are made to the international system, rentier capitalists will continue to magnify their wealth by avoiding taxes.

However, to put the sector in perspective: daring, buccaneering ‘rocket-men’ billionaires like Musk and Branson are the small fry of the global rentier economy. The big beasts are Private Equity (PE) firms like the Carlyle Group, Kohlberg Kravis Roberts (KKR) The Blackstone Group and Apollo Global Management.

Private Equity firms mobilise pools of capital from wealthy individuals, pension funds and hedge funds, and use these savings to take a stake in a business paid for with borrowed money (credit) – a process known as a ‘leveraged buyout’. (Borrowed capital is preferred because debt attracts tax breaks.) Just as we may put down a deposit on a property and purchase the rest with borrowed money, so PE firms put down a comparatively small amount of cash to buy a targeted business and then aggressively borrow (leverage) large sums to pay for the purchase. But whereas you and I take responsibility for repayment of a mortgage, a PE firm does not. Instead it loads the debt on to the targeted firm (say a football club, housing association or railway company) and makes the users of those assets (football fans, residents and travellers) repay the ‘rent’ on the debt – that is, both the interest and principal repayment – by forking out railway fares, football match tickets or monthly rents.

Partly as a result of this parasitic business model, the corporate sector has been saddled with what the IMF believes is about $19 trillion of debt considered “at risk” by firms whose earnings would not cover the cost of their interest expenses in a crisis such as the current one.

Wherever the corpse is, there the vultures will gather (Matthew 24:28)

While the world economy was locked down by coronavirus, with the heavily indebted corporate sector at grave risk of default, PE firms were circling carcasses of bankrupt firms and markets felled by the lethal pandemic.

According to the Financial Times the sector has raised $1.5 trillion of “dry powder” for acquisitions, while US distressed-debt funds are hoping to raise more than $67 billion – a capital-raising effort that would smash the previous $44 billion record of 2008. These trillions will be used to scavenge bargains in whole sectors of the economy. PE firms intend to profit from the current crisis much as they did after the 2008 financial meltdown.

And by tacitly supporting the broken system of financial globalisation, we the citizens have effectively agreed they should do so.

Broken and illegitimate institutions

As Elon Musk was preparing to launch his ‘Starship’, the US economy was in freefall and the nation in political turmoil. Rebecca Spang, historian of the French revolution, warned of parallels.

“Fear sweeps the land”, she wrote. “Many businesses collapse. Some huge fortunes are made. Panicked consumers stockpile paper, food, and weapons. The government’s reaction is inconsistent and ineffectual. Ordinary commerce grinds to a halt; investors can find no safe assets. Political factionalism grows more intense. Everything falls apart. This was all as true of revolutionary France in 1789 and 1790 as it is of the United States today.”

Spang goes on to explain that events transform structures, and when they do it is because events reveal current structures “to be already broken and institutions illegitimate.”

As Elon Musk was preparing to launch his ‘Starship’, the US economy was in freefall and the nation in political turmoil.

The structure of the opaque and apparently remote global financial and trading system is perhaps the most illegitimate of the institutions that govern the lives of the world’s citizens. When President Kennedy called for Americans to unite behind the ambition of ‘a moonshot’ the American space industry operated under public authority. Today it has been privatised.

Back in 1961 the international financial architecture was a system effectively governed by public authority – not by the private authority of Wall Street or the City of London. The situation has now been reversed. Today the international system is effectively governed by creditors, investors and speculators, active in private and globalised capital markets.

It is private creditors who decide on the allocation of credit; on appropriate levels of private debt; and on the rate of interest on debts. And as lending is most profitable when allocated to risky, speculative, rent-seeking ventures – and less profitable when applied to productive, sustainable sectors – creditors make huge capital gains, but expose both firms and the wider economy to the risk of failure.

Hence the growth of private debt beyond the capacity of individual firms to repay debts; and hence the growth of private debt beyond the capacity of the wider economy. According to the IMF’s October 2019 Global Financial Stability Report, vulnerabilities among non-bank financial institutions are now elevated in 80% of economies with systemically important financial sectors. This share is similar to that at the height of the global financial crisis.

To understand how private capital markets ‘govern’ the international system, consider this. Private investors and speculators effectively determine the exchange rates of currencies. The international system grants speculators the power to move capital across borders at short notice, and on a whim. That can both inflate the value of a currency (as money floods in) and have catastrophic consequences when money floods out, and the currency plummets. A weaker currency means the cost of vital imports (e.g. oil and pharmaceuticals) rises. At the start of the coronavirus crisis this was the fate of so-called emerging markets like South Africa, Argentina and Turkey. According to the Institute of International Finance, foreign investors withdrew a record $83 billion from stock and bond markets in the 30 largest emerging economies — “outflows that dwarfed those experienced in the financial crisis of 2008-09”.

And increasingly it is private investors and speculators that have taken ownership of, and are parasitically squeezing rents out of, existing taxpayer-financed assets, like aerospace assets, care homes, railways, health services, prisons; and the energy, electricity and water industries.

Finally, the taxpayer-backed monetary systems of well organised nation states are increasingly distorted to serve the interests of private, globalised capital, not the interests of society. The US Federal Reserve and other central bank operations now provide security and protection to a global rentier class, including private equity (PE) firms that “harness secrecy to fleece investors and taxpayers”. The Fed’s spectacular and unprecedented interventions in March 2020 was as Trevor Jackson argues “to flood financial markets with cash as quickly as possible, so banks could keep lending, buyers of stocks could keep buying, and institutions could keep making their debt payments”. Far from deflating the global debt bubble, the Federal Reserve is keeping debt, and its owners, buoyant.

It is also why, despite its awesome power, the Fed has not succeeded in managing a deeply unstable global economy. Indeed, it may have contributed to economic failure. As the IMF explains in the 2020 Global Financial Stability Report, the Fed turned a blind eye as private credit markets expanded rapidly after the 2007-9 global financial crisis, reaching $9 trillion globally. Simultaneously, weak regulation by central bankers lowered borrowers’ credit quality, and weakened underwriting standards and investor protections. These risky credit markets — in high yield (‘junk’) bonds, leveraged loans and private debt — continued to show stresses through the spring of 2020, despite the Fed’s massive cash injection.

So in the interests of international creditors, the taxpayer-backed Federal Reserve, and other central banks, are propping up heavily over-indebted firms, when the real economy gives every indication of spiralling downwards into deflation. Who benefits from a deflationary spiral? You guessed it: the rentier class. As prices and wages fall, the value of debt rises, as does the cost of servicing debt.

What is to be done?

The simple answer to that question is that private capital markets have to once again be subordinated to the role of servant of economies, not masters.

The first task is for governments to manage, not control, the mobility of cross-border capital flows. That way governments can ensure billionaires like Richard Branson pay taxes.

The second task is for governments and central banks to manage the creation of credit. Credit-based monetary systems are a great civilizational advance – developed over time to enable societies to undertake transactions and put unique human abilities to work. Like sanitation or the water supply, monetary systems are a great public good.

Credit creation is an extraordinary and relatively effortless power that has been captured by the rentier class, for the self-serving interests of the 1%.

And for the rest, the IMF has the answers: stringent supervision of bank credit risk assessment and lending practices, and efforts to increase disclosure and transparency in non-bank finance markets to enable a more comprehensive assessment of risks.

In economies where overall corporate sector debt is deemed to be systemically high, in addition to sector-specific prudential tools for banks, politicians may consider developing prudential tools for highly leveraged firms. Reducing the bias in tax systems that favors debt over equity financing would also help reduce incentives for excessive borrowing.

None of this is rocket science or revolutionary. Of course, there will be resistance from the rentiers.

But we should never forget the lesson of the French Revolution: the rentiers need the state more than the state needs rentiers.


Leave a Reply

Your email address will not be published. Required fields are marked *

This website collects cookies and analytic data. To use our website you must consent.
For more information read our Privacy Policy.