Capitalism, debt and the rate of interest

INEQUALITY graphics are from the new book of Thomas Piketty, Capital and Ideology. Coupled with the new debt projections of the IMF it tells us a strange story. Over the last four decades, inequality – both income and wealth – increased dramatically although the changes differ across regions and countries. This much is well known. Nevertheless, public debt soared during the entire period also. Amidst the German Unification – Treuhand and all that, privatization at breakneck speed, etc. – it was the government that always secured the working of capitalism. Leaving aside calls for ‘small government’, actually governments not only regulate but also direct markets. After all, there was no natural recovery after 2008, and now with the outbreak everything would have collapsed unless governments intervened with a heavy hand. The other strange thing is the growth of debt. Not only sovereign debt reached the level of WWII in advanced economies – therefore government in fact got bigger by that metric – but also debt (credit) grew by leaps and bounds. If this is capitalism, it is less predicated on capital accumulation than mountains of debt. Given a growth ray, although wealth distribution has become more unequal than before in many countries, still capital seems to be the scarce factor.

Now capital is insufficient given growth targets, total factor productivity growth has slowed after Lehman, but also the third factor, labour force, leaves a lot to be desired. Not only jobs are being lost, but also education is faltering, and human capital accumulation is in jeopardy. Technology, AI and suchlike are advancing, and the quanta of science – if such a thing can be measured at all – is accruing, but the translation of new technologies to economic uses hasn’t sped up. Perhaps the outbreak will cut the Gordion Knot and shift unemployment to technological unemployment after losing a few years more. People no wonder talk about another lost decade.


Yet interest rates remain low, near zero and even negative, nominally. This is both a theoretical and a practical issue. It is also ideological because in some regions of the globe people think interest is equal o usury and try to make other systems available for believers. Actually, from the standpoint of the Muslim world, the idea is quite new in its modern guises. It dates back to the 1940s. All religions once objected to usury. However, as economic activity picked up in the 16th century and price inflation made its appearance after the Americas had been discovered, Spanish theologians and jurists did make some changes, adapting the doctrine to growing economies and rising inflations. Protestants took over from there. In the new thinking of the Salamanca School, a new rate of interest corresponded not only to inflation but also to new general price levels. The real interest rate thus began to fluctuate.


In another vein, interest is a function of profit. In a neoclassical competitive general equilibrium model the rate of interest and profit rate are equal. Whether this is an accurate description of the world is another question; it is probably not and has never been. Consider bank capital, for instance: The profit rate should be higher than the cost, i.e. deposit rate. Yet they are related. To any target return on equity capital, a different interest rate might correspond. From an Islamic vantage point, interest and profit share are very similar magnitudes and this has been well documented. Because market economies are both similar and self-similar, the laws of motion are almost the same regardless. There can be no economy without markets. Such ‘experiments’ have failed miserably. What one may call socialism in the future may well involve a higher dose of public and cooperative property and should be more of the libertarian-egalitarian type, but markets will continue to exist. They have been there long before capitalism emerged. Well, anyway, a more cooperative society is not just about how scarce resources are being allocated.


Piketty has been heavily criticized after the publication of his first book in 2014. Still, that book was important and so is the new one. It documents how inequality evolved over the last 40 years. Basically neoliberalism did generate enormous incomes and wealth for the top 10 percentile, and even more for the top 1%. What matters is this didn’t happen because markets were such and such, that they were efficient and what not, etc. This happened because debt increased enormously. No wonder the IMF issued warning after warning for Ems, but advanced economies are even more indebted. Is the whole story based on debt, and on sovereign debt essentially? Has this been an era of financial hypertrophy-cumgovernment transfer to the private sector? Why is it true that global interest rates don’t rise despite huge public debt?


Right, there will always be an interest rate ust as there will be a profit rate. First and foremost, interest is also a function of time preference. Then it is a derivative of the profit rate. Yet it is also a determinant of the profit rate along with the general price level. It is an endogenous variable, both micro and macro. That it was strongly exogenous was suggested by William Vickrey, who shared the Nobel with James Mirlees in 1996. In all imperfectly competitive markets, or in any “real” competition (in the limit) regime the rate of interest ought to be positive in real terms. It can be low or high, but positive, unless the economy is stationary. In that case, the profit rate will also be close to zero and there will be no growth, no inflation, no public debt, no current account deficit etc. Populations would stagnate just as they did for many millennia and technology wouldn’t change much either. It won’t be so because the real rate is near zero, but rather the other way around. It is extremely awkward in my opinion that given global debt levels, interest rates are so low but then there is the debt deflation problem. Because advanced economies can’t generate inflation and because they are satiated in terms of growth, rates of interest are low there, perhaps.


What is going on here? Political risks all of a sudden emerge here, but also they can dissipate quickly. The basic equilibrium-to-be must involve a higher rate anyway. On September 23, just the day before the CBRT hiked by 200 basis points, the effective average funding was at 10.65. It was 11.38 on October 5. It is going up very slowly. Inflation stands at 11.75% annually, and there is no sign it will fall.

Just about 73 basis points increase won’t suffice. Hence, restrictions are gradually being lifted, the London swap market can perhaps re-work, and the tax on TRY deposits was cut so as to render TRY assets attractive. Still, dollarization can’t be easily stopped. I think TRY assets stand a chance now but on the condition that the expected real interest rate is considerably higher than what is current.

Expectations matter, yes. But they change all too often and they may not really offer a fixed point by themselves so equilibrium is reached. In both market valuations for stocks and bonds, and for the macroeconomic balance, multiple equilibria arise all too quickly as subjective, psychological and expectation parameters shift.

Two months ago, the real rate was negative. Now it looks positive. However, if we judge by current and 3 months-ahead inflation, it is very low still. Furthermore, ex post rates are generally lower than ex ante rates, meaning inflation expectations aren’t borne out by events. If the sequence of ‘normalizations’ endure and new steps will be bold enough, TRY assets can become attractive again, especially given that the soaring current account deficit will almost surely fall in 2021.

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