Writing during the depression of the 1930s, Keynes feared that the return to full employment might require a protracted period of low interest rates which could bring about the euthanasia of the rentier classes. In his words: “Now, though this state of affairs (…to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure…) would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital”. J. M. Keynes, General Theory, pp. 375-76.
Keynes was writing his General Theory during a strong bull market in bonds, following the 35% collapse of high grade USA corporate bond yields to below 3.5% from a peak of 5.41% in June 1932. The bull market in bonds would continue for another 10 years, until April 1946, when yields bottomed at 2.46%. Likewise we have lived through a 28-year long bull market in high yield corporate bonds and have gone through a severe recession and financial crisis. The current bull market in bonds and the economic recession are milder than in the 1930s, with a decline of only 15% in corporate yields from 5.79% in June 2007 to 4.88% in June 2010. Yet, in historical terms, these are the closest we have to the 1930s. Like Keynes we do not know if the current bull market will continue for another 10 years. So, it is pertinent to consider whether Keynes predicament in relation to the euthanasia of capitalists is still valid today.
With the benefit of history we now know that his fears were unwarranted. Indeed, the next bear market in bonds, which would last until 1981, ran throughout the years of the fastest economic growth known to humanity (the golden fifties and sixties). Similarly, after the current 28-year bull market in bonds that began in 1982, we now know that the wealthy are well and getting richer. In fact, they have probably just gone through the period of greatest wealth concentration ever experienced in the USA and many other countries. Last April, the Congressional Budget Office in the USA published data showing that the real after-tax average income of the Top 1 percent income group had almost quadrupled between 1979 and 2007 while the income of those in the bottom 3 quintiles (the lowest 60%) barely moved during the past 29 years.
To be fair, with the possible exception of Japan, no country has ever come near to the almost 0% yield envisaged by Keynes. Nevertheless, there is no doubt that his predicament is outdated and wrong. Yet, because of the risk that an excessive concentration of wealth represents for the future of capitalism, we need to delve further on the reasons why he got it wrong. In our view, the two main reasons were his excessive reliance on the role of interest rates as a determinant of the level of investment required by full employment and his outdated view on how the rich got richer.
Beginning with the way the rich get richer, there are nowadays three important sources of wealth that were disregarded by Keynes. First, there is a new breed of millionaires that make their fortune as corporate raiders. These include private equity and hedge fund managers, investment bankers, CEOs and Non-executive Directors involved in corporate acquisitions and restructurings. To illustrate this new reality one has only to look at the ten-fold increase in their compensation packages, from a ratio of 20:1 during the Robber Baron’s years of the early 20th century to the current 200:1 ratio. Some anecdotal evidence reported by Robert Frank in his book Richistan: a Journey Through the American Wealth Boom and the Lives of the New Rich even shows that some millionaires now make more money from Non-executive directorships than from the returns on their wealth. Second, many of the wealthy have now a large percentage of their portfolio invested in equity, real estate, commodities and alternative investments which are not always correlated with fixed-income and which had a tremendous run in the past 30 years. This greater reliance on capital appreciation rather than on capital growth decouples a large share of their wealth growth from interest rates. Finally, the growth in offshore investment and a cap in progressive income taxation with the top rates generally below the share of public spending in the economy (or even declining as in the USA) have benefited the wealthy.
Turning now to the role of interest rates as determinants of the level of investment, we can see that Keynes missed an important determinant of investment – the level of leverage. As we have shown elsewhere, in a credit-based economy like ours, the marginal efficiency of capital is shifted by leverage making its influence on the level of investment equally or even more important than the level of interest rates. So those able to use higher levels of leverage (like the financiers) are in a better position to accumulate a disproportionate share of income and wealth, in particular when governments underwrite their excessive risk-taking through bail-outs.
We conclude, by paraphrasing Mark Twain, and state that “the announcement of the rentiers’ death was premature”. And complete it by adding our own pronouncement that to secure a vibrant market capitalism we must tackle the problems caused by the new sources of wealth accumulation and financial leverage.