China Needs a Vigorous Income Policy
 
By
Henry C.K. Liu
 
 
In his opening speech at the 18th National Congress of the Communist Party of China (CPC) on November 8, 2012, retiring General Secretary Hu Jintao, representing the Secretariat of the 17th Party Congress held five years earlier, summed up the achievements of his two five-year terms as paramount leader, and set for his successor, Xi Jinping, among other goals, a target of doubling income for all Chinese workers by 2020, 8 years hence.
 
While it is encouraging that the CPC's newly installed fourth-generation leadership is formally bound to a proactive national income policy of raising worker wages, the timid pace of that commitment is disappointing. Wages in China are currently about one fifth of wages in the US. Doubling Chinese wages by 2020 would mean that Chinese wages would still be four times lower than those in the US, even assuming that US wages do not rise during that period, which is highly unlikely, given that progressive political sentiment in the US has been on the rise since the global financial crisis started in New York in mid 2007.
 
The labor union movement in the US, after courageous struggle, has managed to make wages in union contracts indexed to inflation in recent decades, causing wages to rise at the same pace as officially recognized inflation to keep wage earners from losing real purchasing power, albeit the stickiness of wages is still a deterrent to full value indexation.
 
The wage/inflation indexation is structurally only a game in futility to keep wage earners running in place on a wage/inflation treadmill to give them the illusion of catching up in the financial game in life in an inherently anti-labor capitalist society, while in fact wage earners are actually falling steadily behind in uneven inflation. Wages indexed to official inflation indices are distorted by the official definition of wage increases as a prime cause of inflation while the official definition of asset price appreciation is economic growth rather than inflation. Thus the distributional effect of economic growth is structurally set against wage earners. The more the economy grows, the smaller is the wage earners' collective share of the benefits from growth, while in absolute terms, wage earners are getting higher wages supposedly to keep pace with inflation.
 
The most egregious flaw of capitalism, both industrial and financial, is their efficient performance inherently produces extreme inequality as an operational outcome. Continuous capital formation, the seed of capitalistic growth, and maximum return of capital, the driver of capitalistic growth, both require distributional inequality of income and wealth, that if unchecked by government regulations, will lead to social instability.
 
For a capitalistic economy to function optimally, worker wages must lag behind inflation structurally to keep profit ahead of inflation. Capitalist profit is inversely related to cost, the most flexible of which tends to be wages. This fact is made obscured by allowing employed wage earners access to easy credit through their friendly neighborhood mortgage broker on home mortgages supposedly collateralized by their wage income. As wages stagnated, home mortgages were left to be collateralized by an expanding home price bubble sustained by central bank loose monetary policy.
 
Low wages were also compensated by giving wage earners easy access to consumer loans at exorbitant interest rates from credit card issuing banks. Outstanding credit card debt at 18% interest rate compounded and minimum payment of only 2% of outstanding debt essentially doubles the purchase cost to card card holders if the debt is kept outstanding for just five years. Many credit card holders routinely owe the maximum allowable outstanding debt balance perpetually, essentially reducing their real purchasing power by half through exorbitant interest payments.
 
With the securitization of debt, the home mortgages issuers did not care if these low-wage sub-prime borrowers should default on their high mortgages secured by the home price bubble because such mortgage debts would be packaged as mortgage-backed securities and sold the very next day to faceless investors worldwide lured by high yields with low-cost default insurance. In this scheme of debt securitization, sub-prime mortgages were not recorded on the balance sheet of the lending banks to cause them to maintain high reserves for bad loans, or to increase capital requirement that would have direct adverse effect on bank profits.
 
Aside from homes mortgages, credit card issuers also packaged installment-payment loans as collateralized debt obligation (CDO) securities backed by consumer credit installment payments or credit card billing payments that are sold to investors in global credit markets.
 
Structured finance involves a bundle of mortgage debt being structured into a vertical stack of mortgage-backed securities with progressive levels of risk designed to be sold to a range of investors with varying risk appetite for compensatory yields.
 
When a particular debt instrument can be structured for sale not as a integral instrument with the good and the bad being inseparable, but as a range of trenches of graduated risk levels tied to compensatory yields and sold to investors with varying risk appetite for compensatory yields in a global credit market, more financial value can be squeezed out from the debt. As a result, interconnected structured finance markets around the world grew explosively like mushrooms in a rain forest.
 
Safety from counter-party default in such structured debt instruments was insured with credit default swaps (CDS) at low risk premium that essentially translated into a market-wide under-pricing of risk through transfer of unit risk to systemic risk.
 
From a macro systemic perspective, when unit risk is transferred to systemic risks, while relieving the obligation of the risk-taking unit, the transferred risk cannot be mistaken as risk removed from the credit system. The risk stays in the credit system with a new profile that includes the cost of the transfer from unit to system.
 
A special purpose vehicle (SPV) is a legal entity created to fulfill narrow, limited, specific and temporary objectives. SPVs are typically used by a company to isolate itself from financial risk associated with a particular financial exposure. They are also commonly used to hide debt obligation with the purpose of inflating profits; to hide ownership of a risk exposure, or to obscure legal relationships between different entities which are in fact related to each other. SPVs were abusively used by Eron to build its profit house of cards.
 
Normally a company will transfer assets to a SPV as a tactic of risk management, or use a SPV to handle the finance a large project thereby achieving a narrow set of financial/business goals without putting the entire company at risk. SPVs are also commonly used in complex financing to separate different layers of equity infusion. Commonly created and registered in tax havens, SPV's allow tax avoidance strategies unavailable in the home district. Round-tripping is one such strategy. In addition, SPVs are commonly used to own a single asset and associated permits and contract rights (such as an apartment building or a power plant), to allow for easier transfer of that asset. They are an integral part of public/private partnerships common throughout Europe which rely on a project finance type structure.
 
A SPV may be owned by one or more other entities and certain jurisdictions may have regulation requiring ownership by certain parties in specific percentages. Often it is important that the SPV not be owned by the entity on whose behalf the SPV is being set up (the sponsor). For example, in the context of a loan securitization, if the SPV securitisation vehicle were owned or controlled by the bank whose loans were to be secured, the SPV would be consolidated with the rest of the bank's group for regulatory, accounting, and bankruptcy purposes, which would defeat the point of the securitization. Therefore some SPVs are set up as 'orphan' companies with their shares settled on charitable trust and with professional directors provided by an administration company to ensure that there is no legal connection with the sponsor.
 
An orphan structure is a company whose shares are held by a trustee on a non-charitable purpose trust. The company is said to be an "orphan" as it is not beneficially owned by anyone. Orphan structures are usually used in offshore structures to ensure that the assets and liabilities of the subject company are treated as "off-balance-sheet" with respect to the sponsor of the structure. Other reasons for creating an orphan structure are to avoid or minimize regulation which might otherwise apply to a structure, and to ensure that the company is "bankruptcy remote" from companies in the same group as the sponsor. Orphan structures are relatively common features of securitization vehicles, where the asset backed bonds are issued by the orphan company.
 
Off-balance-sheet loans issued through SPVs relieved the issuing institution from default risk, but the risk stayed in the credit market system. Since such loans were off balance sheet, the issuing bank could issue much more debt than if the loans were on balance sheet as long as the debt securities can attract buyers in the debt market. The result is a credit market with systemic risk bubble.  When enough unit risks are transferred to systemic risks, the credit system can be overloaded with serious under-pricing of risk coupled with insufficient loan reserves, leading to systemic credit market failure when the debt bubble burst through the risk interconnectedness of financial derivatives.   
 
On November 25, 2008, not waiting until 2009 as previously announced, the Federal Reserve (Fed) and the US Treasury moved up the launch of the Troubled Assets Relief Program (TALF) “to support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).”
 
The on-going record of the ineffectiveness of TALF would give some idea of what the European Central Bank (ECB) would face since it was pushed to take similar measures by US Treasury Secretary Tim Geithner in 2011, even though TALF was designed to deal with commercial and consumer debt while the ECB was facing a crisis of sovereign debt.

TARP allows the U S Department of the Treasury to purchase or insure up to $700 billion of "troubled assets," defined as
(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and
(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.
 
In short, TARP allows the Treasury to purchase illiquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007, when they were hit by widespread foreclosures on the underlying loans.
 
TARP is intended to improve the liquidity of these assets by the Treasury purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.
 
The Emergency Economic Stabilization Act of 2008 (EESA) requires financial institutions selling assets to TARP to issue equity warrants (a type of security that entitles its holder to purchase shares in the company issuing the security for a specific price), or equity or senior debt securities (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury will only receive warrants for non-voting shares, or will agree not to vote the stock. This measure is designed to protect taxpayers by giving the Treasury the possibility of profiting through its new ownership stakes in these institutions. Ideally, if the financial institutions benefit from government assistance and recover their normal financial strength, the government will also be able to profit from their financial recovery.
 
Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets. Increased lending equates to "loosening" of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending.
 
TARP will operate as a "revolving purchase facility." The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the coupons. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets. The initial $250 billion can be increased to $350 billion upon the President's certification to Congress that such an increase is necessary. The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then has 15 days to vote to disapprove the increase before the money will be automatically released. The first $350 billion was released on October 3, 2008, and Congress voted to approve the release of the second $350 billion on January 15, 2009. One way that TARP money is being spent is to support the "Making Homes Affordable" plan, which was implemented on March 4, 2009, using TARP money by the Department of Treasury. Because "at risk" mortgages are defined as "troubled assets" under TARP, the Treasury has the power to implement the plan. Generally, it provides refinancing for mortgages held by Fannie Mae or Freddie Mac. Privately held mortgages will be eligible for other incentives, including a favorable loan modification for five years.
 
The authority of the US Department of the Treasury to establish and manage TARP under a newly created Office of Financial Stability became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other acts.

The Fed announced in 2008 that under TALF, the Federal Reserve Bank of New York (NY Fed) would lent up to $1 trillion (originally planned to be $200 billion) on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. As TALF money did not originate from the Treasury, the program did not require congressional approval to disburse funds, but a new act of Congress forced the Fed to reveal how it actually spent the money.

The Fed explained the reasoning behind the TALF as follows:
“New issuance of ABS declined precipitously in September and came to a halt in October. At the same time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums. The ABS markets historically have funded a substantial share of consumer credit and SBA-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads”

According to the plan, the NY Fed would spend up to $200 billion in loans to spur the market in securities backed by payments from loans to small business and consumers. Yet, the program closed after only funding the purchase of $43 billion in distress loans.

Under TALF, the Fed lent $1 trillion to banks and hedge funds at nearly interest-free rates. Because the money came from the Fed and not the Treasury, there was no congressional oversight of how the funds were disbursed, until an act of Congress forced the Fed to open its books. Congressional staffers then examined more than 21,000 transactions. One study estimated that the subsidy rate on the TALF’s $12.1 billion of loans to buy Commercial Mortgage-Backed Securities (CMBS) was 34 percent.

TARP allows the Treasury to purchase illiquid, difficult-to-value assets at full face value from banks and other financial institutions. The targeted assets can be collateralized debt obligations (CDO), which were sold in a booming market until July 2007, when they were hit by widespread foreclosures on the underlying loans.

TARP is intended to restore liquidity of these assets in a failed market with no other buyers, by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.

TARP does not allow banks to recoup losses already incurred on troubled assets, but Treasury officials expect that once trading of these assets resumes, their prices will stabilize and ultimately increase in value, resulting in gains to both participating banks and the Treasury itself. The concept of future gains from troubled assets comes from the hypothesis in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate. Yet the low default rate was not produced by economic conditions, but by the Fed’s financial manipulation. Thus the banks are saved, but not the economy as a whole, which ultimately still has to pay off the undistinguished debt.

The Emergency Economic Stabilization Act of 2008 (EESA) requires financial institutions selling assets to TARP to issue equity warrants (a type of security that entitles, but without the obligation, its holder to purchase shares in the company issuing the security for a specific price), or equity or senior debt securities (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury will only receive warrants for non-voting shares, or will agree not to vote the stock.

This measure is supposedly designed to protect taxpayers by giving the Treasury the possibility of profiting through its new ownership stakes in these institutions. Ideally, if the financial institutions benefit from government assistance and recover their former strength, the government will also be able to profit from their recovery.

Another important goal of TARP is to encourage banks to resume lending again at levels seen before the crisis, both to each other and to consumers and businesses. If TARP can stabilize bank capital ratios, it should theoretically allow them to increase lending instead of hoarding cash to cushion against future unforeseen losses from troubled assets.

The Fed argues that increased lending equates to “loosening” of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending. So far, this goal has not been achieved as bank merely used TARP money to deleverage rather than increase lending.

TARP will operate as a “revolving purchase facility”. The Treasury will have a set spending limit, $250 billion at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the “coupons”. The money received from sales and coupons will go back into the pool, facilitating the purchase of more assets.

The initial $250 billion can be increased to $350 billion upon the president's certification to Congress that such an increase is necessary. The remaining $350 billion may be released to the Treasury upon a written report to Congress from the Treasury with details of its plan for the money. Congress then has 15 days to vote to disapprove the increase before the money will be automatically released. The first $350 billion was released on October 3, 2008, and Congress voted to approve the release of the second $350 billion on January 15, 2009.

One way that TARP money is being spent is to support the “Making Homes Affordable” plan, which was implemented on March 4, 2009, using TARP money by the Treasury. Because “at risk” mortgages are defined as “troubled assets” under TARP, the Treasury has the power to implement the plan. Generally, it provides refinancing for mortgages held by Fannie Mae or Freddie Mac. Privately held mortgages will be eligible for other incentives, including a favorable loan modification for five years.

The authority of the Treasury to establish and manage TARP under a newly created Office of Financial Stability (OFS) became law October 3, 2008, the result of an initial proposal that ultimately was passed by Congress as H.R. 1424, enacting the Emergency Economic Stabilization Act of 2008 and several other related acts.

Collateral assets accepted by TARP include dollar-denominated cash ABS with a long-term credit rating in the highest investment-grade rating category from two or more major “nationally recognized statistical rating organizations (NRSROs)” and do not have a long-term credit rating below the highest investment-grade rating category from a major NRSRO. Synthetic ABS (credit-default swaps on ABS) do not qualify as eligible collateral. The program was launched on March 3, 2009.

Special Purpose Vehicle – Financial Neutron Bomb

TALF money was designed not to go directly to targeted small businesses and consumers, but to the institutional issuers of asset-backed securities (ABS). The NY Fed would take the securities as collateral for more loans to the issuers of ABS. To manage the TALF loans, the NY Fed created a Special Purpose Vehicle (SPV) that would buy the assets securing the TALF loans. The function of a SPV is to isolate risk from the creator, in this case the NY Fed, as a device to hide debt from the balance sheet of the creator. In the case of TALF, the SPV creator is ultimately the NY Fed's parent, the Federal Reserve, the nation’s lender of last resort to banks.

SPVs are financial neutron bombs, used in war to kill enemy population without causing damage to physical assets, thus saving reconstruction time and cost in captured enemy territories. A neutron bomb is a fission-fusion thermonuclear weapon (hydrogen bomb) in which the burst of neutrons generated by a fusion reaction is intentionally allowed to escape from the weapon, rather than being absorbed by its containing components. The weapon’s X-ray mirrors and radiation case, normally made of uranium or lead in a standard bomb, are instead made of chromium or nickel so that the neutrons can escape to kill enemy troops and civilians, leaving empty undamaged cities for occupation by the winner in a battle.

The Fed's plan for eventual wind-down of its financial bailout and economic stimulus measures by selling in the open market some of its vast holdings of mortgage backed securities and Treasuries when the economy recovers faces the possibility of massive losses which could force the central bank to suspend annual payments of its profit to the Treasury for the first time since the 1930s.
 
The Fed is holding some $3 trillion in Treasuries as of February 2013, and is adding about $85 billion a month to keep interested rates low and to provide liquidity to the market in an effort to keep unemployment from rising. In 2012, the Fed contributed $89 billion to the Treasury to reduce a significant portion of the government's borrowing and interests costs. But as the Fed sells its holdings on economic recovery, the Fed must also raise interest rates to combat inflation, which will push down the market value of the low-rate securities in its holding to cause significant financial loss.
 
A Fed analysis published in January 2013 which projects interest rate at 3.8% later in the decade, show the Fed incurring a record loss of $40 billion which would force it to suspend payment ot the Treasury for four years beginning 2017. If interest rate rises another percentage point, the resultant loss would triple. This would put political pressure on the independence of the Fed to set interest rates. Worse yet, if the Fed fails to pull its own weight and becomes an added burden to the public debt, political momentum to abolish the Fed will gain strength.   
 
Central Bank uses SPV to Hide Expansion of Balance Sheet

The Treasury's Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 would finance the first $20 billion of troubles assets purchases by buying distressed debt in the NY Fed’s SPV. If more than $20 billion in assets are bought by the SPV through TALF, the NY Fed will lend the additional money to the SPV. Since a loan is treated in accounting as an asset, the NY Fed, by providing the funds to buy distress debt, actually expands it balance sheet positively while its SPV assumes more liability.

SPV used to Skirt Basel II Capital Requirements

In a May 14, 2002 AToL article: The BIS vs National Banks, I warned about Special Purpose Vehicles (SPV) five years before the credit crisis broke out in July 2007:
            “While Third World banks that do not meet BIS capital requirements are frozen from the global interbank funds, BIS rules have been eroded by so-called large, complex banking organizations (LCBOs) in advanced economies through capital arbitrage, which refers to strategies that reduce a bank’s regulatory capital requirements without a commensurate reduction in the bank’s risk exposures. One example of such arbitrage is the sale, or other shift-off, from the balance sheet, of assets with economic capital allocations below regulatory capital requirements, and the retention of those for which regulatory requirements are less than the economic capital burden.

            “Aggregate regulatory capital thus ends up being lower than the economic risks require; and although regulatory capital ratios rise, they are in effect merely meaningless statistical artifacts. Risks never disappear; they are always passed on. LCBOs in effect pass their unaccounted for risks onto the global financial system. Thus the fierce opponents of socialism have become the deft operators in the socialization of risk while retaining profits from such risk socialization in private hands.

            “Set for 2004, implementation of the new Basel II Capital Accord is meant to respond to such regulatory erosion by LCBOs. “Synthetic securitization” refers to structured transactions in which banks use credit derivatives to transfer the credit risk of a specified pool of assets to third parties, such as insurance companies, other banks, and unregulated entities, known as Special Purpose Vehicles (SPV),       used widely by the likes of Enron and GE. The transfer may be either funded, for example, by issuing credit-linked securities in tranches with various seniorities (collateralized loan obligations or CLOs) or unfunded, for example, using credit default swaps. Synthetic securitization can replicate the economic risk transfer characteristics of securitization without removing assets from the originating bank’s balance sheet or recorded banking book exposures.

            “Synthetic securitization may also be used more flexibly than traditional securitization. For example, to transfer the junior (first and second loss) element of credit risk and retain a senior tranche; to embed extra features such as leverage or foreign currency payouts; and to package for sale the credit risk of a portfolio (or reference portfolio) not originated by the bank. Banks may also exchange the credit risk on parts of their portfolios bilaterally without any issuance of rated notes to the market.”
 
Low Wages Made Tolerable With Consumer Debt
 
Instead of being made aware of have been trapped in an unsustainable high-speed debt joy ride in a housing price bubble that would end badly for both borrowers and creditors, US wage earners were misled to think they had found new financial paradise on earth in a new wonderful age of credit miracle that made them financially more sophisticated and better off than their conservative thrifty parents.
 
Easy credit released by central bank loose monetary policy provided low-wage earners with ample debt money to live in bigger and better-equipped homes, to drive larger and faster cars, take exotic jet-set vacations, and to put their children through college with student loans that only needed to be paid back with the student's post-graduation salaries, all achieved by tapping into the regularly increasing size of the mortgages on their homes, the biggest leveraged asset in the average family's financial portfolio, the expected rising market price of which would allow already highly leveraged borrower/owners to take out additional cash by taking .on additional debt through cash-out equity refinancing that put additional spendable cash in their bank accounts without altering the conservative debt to equity ratio of the outstanding mortgage. This joy ride of the  mortgage debt bubble was expected to go on forever with ample liquidity expected to be released by an accommodating central bank to keep the housing bubbles expanding forever without causing inflation.
 
The cash-out proceeds from refinanced equity loans were used by home owners to pay for the good life. The refinancing was supported by the rising market price of the mortgaged homes, pushing the indebtedness way beyond the ability of the borrower's wage income to meet interest and amortization payments.
 
Home equity refinance became a huge Ponzi scheme to pay the cash-outs with the proceeds of new additional debt based on anticipated further rise in the market price of the mortgaged home in a gigantic real estate price bubble created by central bank loose-money monetary policy that treated real estate market price increase as desirable economic growth and treated wage increases as undesirable cause of inflation. Mortgage-backed securities because the largest component in the structured finance market and the main driving factor in economic expansion while wages remained stagnant.
 
US workers were getting debt-rich by simply watching their homes bought with 100% debt, increase in price by 30% every years, so that after merely a few years of high-leverage home ownership, most of the nation's workers were living in homes with outstanding mortgages their stagnant wages could not possibly pay. For many wage earners, the home became a private ATM (Automatic Teller Machine) fed by refinanced mortgages that the owners' wage income alone could not service without more periodic recurring cash-out equity refinancing, with a good portions of the cash out proceed going to pay for new cars, exotic vacations, second and third homes bought with "no down payment/no income verification" mortgages on the full purchase price with the expectation that the market value of the property will rise perpetually to justify a new Ponzi scheme of home ownership made possible with central bank monetary policy.
 
Chairman Greenspan of the Federal Reserve Board labeled the phenomenon as the "wealth effect" of a growing real estate market made possible by the Federal Reserve lax monetary policy under his chairmanship. For releasing the biggest debt bubble in history, Greenspan was revered in Congressional hearings as the new King Mida with the Golden Touch, instead of the Wizard of Bubbleland. (Please see my September 14, 2005 AToL series on Greenspan - Wizard of Bubbleland, written two years before the debt bubble burst in mid July, 2007)
 
Wage Labor and Capital
 
Karl Marx (1818-1883) wrote Wage Labor and Capital in 1847 which was first published in April 1849 as a series of articles in Neue Rheinische Zeitung, a German daily published by Marx in Cologne between June 1, 1848 and May 19, 1849. This newspaper is regarded by historians as one of the most important dailies in Germany on the failed 1848 Democratic Revolutions all over Europe.
 
The term “capitalism” did not appear in the English speaking world until 1854, seven years after Marx wrote Wage Labor and Capital in 1847 while the term communism was used in German by Karl Marx in 1848. Communism is a term that describes a socio-economic-legal-political system based on common ownership of property, particularly the means of production.

According to the Oxford English Dictionary (OED), the term capitalism was first used by novelist William Makepeace Thackeray in 1854 in The Newcomes, by whom he meant those "having ownership of capital”. Also according to the OED, Carl Adolph Douai, a German-American socialist and abolitionist, used the term private capitalism in 1863.
 
Modern capitalism is the natural financial outcome from Calvinist precepts of thrift, hard work and savings. Protestant reformation in England provided the spiritual framework for the emergence of industry and the religious mindset from which rose industrial capitalism.
 
Nowadays, capitalism is the name given to a socio-economic system driven by the desire for and action of ceaseless production of more capital with capital through the market mechanism. The economics of captialism has morphed into the economics of the market, allowing behavior finance to take center position in finance capitalism. The old issues of industrial capitalism seem to have reached a stage of full maturity in which further breakthroughs are not expected to come forth. The economics of finance, particularly behavioral finance that is intermediated through the price system, seems to have attracted the attention of the brightest minds in economics.   
 
Since World War II, the term "capitalism" has been gradually displaced by the more benign label of the free market. Capitalism ceased to be mentioned in most economic literature. In the process, economists also squeezed out of official dialogues the word "capitalism", the once traditional name for the market system, with its subjective connotation of class struggle between owners of capital, through their professional managers, and workers, through their trade and industrial unions, and with its legitimization of the privileges that go with various levels of wealth.

The word "capitalism" no longer appears in textbooks for Economics 101. A Harvard economist, N Gregory Mankiw, author of a popular new textbook, Principles of Economics, told the New York Times: "We make a distinction now between positive or descriptive statements that are scientifically verifiable and normative statements that reflect values and judgments." A whole new generation of economists have grown up thinking of "capitalism" only as a historical term like "slavery", unreal in the modern world of market fundamentalism.
 
In the afternoon of Wednesday November 2, 2011, nearly 70 Harvard student protesters walked out of Professor Mankiw's course: Economics 10, expressing dissatisfaction with what they perceived to be an overly conservative bias in the course, in a show of support for the “Occupy Wall Street” movement’s principal criticism that conservative economic policies have increased income inequality in the United States and around the world.
 
“Harvard graduates have been complicit [and] have aided many of the worst injustices of recent years. Today we fight that history,” said Rachel J. Sandalow-Ash, class of 2015, one of the students who organized the walkout. “Harvard students will not do that anymore. We will use our education for good, and not for personal gain at the expense of millions.” Gabriel H. Bayard, class of 2015, another organizer of the walk out, said that he believes the course is emblematic of the economic policies that have led the financial crisis.
 
“Ec 10 is a symbol of the larger economic ideology that created the 2008 collapse. Professor Mankiw worked in the Bush administration, and he clearly has a conservative ideology,” Bayard said. “His conservative views are the kind that created the collapse of 2008. This easy money focus on enriching the wealthiest Americans—he really operates with that ideology.”
 
Mankiw served as the chairman of the Council of Economic Advisers during the second Bush Administration and was adviser to former Mass. Governor Mitt Romney’s unsuccessful presidential campaign. Mankiw declined to comment for the NY Times report.
 
Sandalow-Ash said that the course too heavily asserts conservative economic claims as fact. “It’s a class that’s very indoctrinating, and does not encourage diversity of views. Economic questions are not always clear-cut. Multiple views should be presented in this course,” Sandalow-Ash said to the press.

Capital, when monetized in a national currency, is in essence sovereign credit from government. Capitalism in a money economy is a system of government credits. Thus a case can be made that in a capitalistic democracy, access to capital and credit should be available equally to all in accordance with national purpose and societal needs. The anti-statist posture of neoliberalism is not only logically flawed, but its glorification of a private-debt economy will inevitably lead to self-destruction of the economy.

February 25, 2013

Next:The Industrial Revolution and Wage Labor