As far as the US economy is concerned, Greenspan isn’t optimistic. “We’re in trouble basically because productivity is dead in the water…Real capital investment is way below average. Why? Because business people are very uncertain about the future.”
Business people are always “very uncertain about the future.” “uncertainty” is an inherent characteristic of the thing known as “future.” It is inherently unknown, left to entrepreneurs (businessmen) to judge, estimate and even guess as to the best course of action.
Increasing productivity requires increasing real capital investment – machinery, equipment, technology, education, etc. Increasing productivity requires allowing failing businesses to fail – there is nothing productive about allowing unproductive companies (those unable to satisfy customer demands profitably) to limp along.
Both mechanisms have been deformed and even halted, directly due to the actions of the Federal Reserve and the US Treasury. Let’s take them one at a time.
As Greenspan notes, “real capital investment is way below average.” Why is capital investment way below average? We see the reasons why in public markets: low interest rates have greatly reduced the universe of potentially profitable capital investments.
Every investment will look for return commensurate to risk. When returns of a major asset class – in this case, Treasuries – are driven to near zero, investors will look elsewhere, bidding up prices and driving down returns. Investments are not compartmentalized – the returns in one arena help determine the prices of assets in another arena. Prices of assets have been driven up in search of return.
Uncertainty about the future is constant. If I am uncertain about the future but my analysis suggests a potential 20% return, I might be willing to invest. If I am equally uncertain about the future but my analysis suggests a potential 2% return, I might keep my money in my pocket.
The uncertainty is constant; the potential return for dealing with uncertainty has been reduced to near zero. This is why “real capital investment is way below average.”
And the solution being proposed is to drive interest down even further. Go figure.
Now, allowing failing businesses to fail. By definition, failing businesses are employing assets in unproductive ways. Allowing for the removal of those assets from the hands of the failing entrepreneurs and allowing the assets to be purchased by the highest bidder is the only way to increase the productivity of these assets. It does not guarantee success, but it guarantees the end of continued failure.
We have seen the combination of the Fed and the US Treasury stop the process in both arenas. Interest rates were not allowed to find their own level; the bankruptcy of every major bank and several industrial firms was circumvented. Many businesses today continue to limp along solely due to the availability of cheap credit.
As an aside…what is curious to me is that the interest rate mechanism may have suffered long-term damage. There is so much credit available today – sitting in excess reserves and due to the several episodes of quantitative easing – the supply of available credit is so far exceeding demand that prices for assets can only be bid up with the result that returns will remain lower.
Until this excess is drained or otherwise consumed, we may never escape from the issues that underlie Greenspan’s concerns. Of course, the draining of liquidity required to move the federal funds rate up even 0.25% has sent shivers through markets, but this is a story for another day.
Instead of focusing on these underlying issues, Greenspan blames the situation on uncertainty about the future, as if this is something new.