INEQUALITY: THE ACHILLES HEEL OF CAPITALISM

While Karl Marx got some things very wrong, like the labor theory of value, communism and the Dictatorship of the Proletariat, he was spot on about the Achilles’ Heel of capitalism — the obsessive compulsion of those at the top of the food chain to accumulate, accumulate, accumulate, resulting in periodic meltdowns, like the Great Depression and its recent cousin, the Great Recession, in turn producing civil disorder, and, sometimes, violent revolutions and wars (often as a pretext to sidetrack revolutions).

Even after seeing it in 2007-2009, most people still don’t understand the mechanism by which the inequality created by this compunction at the top to accumulate produces the financial crises and economic collapses: It begins with the suborning of the political process by the moneyed interests, which then proceeds to feather the nests of the rich and powerful elites by reducing their tax burden, hobbling government regulation of their predatory commercial activities and siphoning government largesse into their coffers with military spending and cronyism. Sound familiar? The net result is the rich get stupendously richer as they scoop up virtually all the benefits of economic growth, the poor become desperately poorer and the middle class marks time. To satisfy their aspirations for consumption, the middle class, and as many of the poor as are able, will borrow money, from the rich, who having accumulated fortunes far in excess of their needs, are more than happy to oblige with easy credit, creating asset bubbles in stocks and real estate. Eventually, the burden of debt weighing on middle- and lower-class borrowers exceeds their ability to service and repay, and the house of cards built on a foundation of debt collapses, credit dries up, bubbles deflate, financial institutions go under and the economy tanks. (See: “Wealth Inequality Caused the Great Recession” in my January 20, 2012  blog www.cassandra-chronicles.blogspot.com)

It is important to recognize the direct connection between excessive inequality of wealth and financial/economic/social calamity, not just in capitalist societies, but any society in which the wealthy game the system to accumulate a wildly disproportionate share of society’s scarce resources. We see the phenomenon occurring in feudal and mercantilist economies, of which the French revolution is the classic illustration. Simon Schama’s excellent “Citizens” explains how the ruling French nobility and clergy largely exempted themselves from taxes, shifting the burden to the peasant, artisan and merchant classes, while granting themselves special commercial advantages by gaining favor at court. The resulting inequality, aggravated by food shortages caused by a particularly severe winter in 1788-89, created the economic polarization leading to the French Revolution in the summer of 1789.

The economic and social turmoil produced by the polarization of wealth via the political process becomes even more acute when compounded by the periodic economic transformations wrought by new energy/technology combinations, such as the Industrial Revolution (launched around 1780), the Petro-Industrial Revolution (launched in earnest after World War I), and more recently, the Electronic Revolution (which gained momentum in the 1980s). Here’s a synopsis on the subject from my book, “The Predicament” (www.the-predicament.com):

Megacycles

Throughout history, changes in dominant forms of energy and technology have combined to create what I call economic Megacycles, such as the Industrial Revolution, combining mechanical technology and coal, and what I call the Petro-Industrial Revolution (usually referred to as the “Second Industrial Revolution”), combining electro-mechanical technology and oil. Each of these Megacycles produced radical changes in occupations, habitat, modes of transport, diet, lifestyle, politics. In short, almost every facet of human existence changes with each Megacycle.

(See: www.cassandra-chronicles.com/Presentations/megacycles.ppt)

Historically, Megacycles have progressed in three phases:

        I.     Rapid economic growth and job creation to adapt to the new economic paradigm, over-investment in the new technology and energy, and euphoria creating a bubble in stock/asset prices.

      II.     Stock market crashes undermining investor confidence and investment, resulting in a Great Depression, skyrocketing unemployment and political discontent, followed by war.

    III.     Postwar, peace and prosperity, based on mature growth of the new energy-technology combination, and relatively benign economic and investment cycles trending upward in an extended period of generally good times – until the next Megacycle comes along.

In the 1990s, we enjoyed the fruits of the first phase of a new Megacycle, the Electronic/High-Tech Revolution, completing the shift in dominance from electromagnetic technology to electronic technology (begun in the 1950s with the introduction of transistors), giving rise to the personal computer, the Internet, smart cell phones, iPods, flat-screen TVs, GPS navigational systems and myriad other commonplace electronic devices and services we never imagined back in the sixties. Burgeoning biotechnology, nano-technology and other forms of technology complemented the Electronic/High-Tech Revolution. However, since oil remains the dominant form of energy, the current Megacycle must be considered only partially realized, awaiting the development of substitutes for hydrocarbons to complete the transformation.

What happens when you superimpose the inequality of wealth produced by the corruption of the political process (such as initiated by Reaganomics in the 1980s)  with the redistribution of resources produced by the transformation of a Megacycle (which reached a climax in the 1990s), is the two forces become mutually reinforcing, (like the constructive interference of two waves in sync) widening the amplitude of both the economic wave and the inequality it produces. The predictable end result is a heightened crest in the economic wave followed by a severe financial crisis and economic meltdown, such as we experienced in the 2000s, accompanied by social polarization, unrest and war. In the U.S., we witnessed this phenomenon previously in the 1850s, the 1930s.

For the record, I foresaw all this clearly in the late 1990s, as demonstrated in a speech I delivered to 200 Chairmen of the Board and Chief Executive Officers at the 115th annual meeting of the Association of Edison Illuminating Companies at the Greenbriar Resort in West Virginia on October 15, 1999. (You can listen to most of it at http://www.smithspeaker.com/audio.html or read about it at http://www.smithspeaker.com/pdf/AEICatGreenbriar.pdf

I titled the speech “7 Clouds in the Silver Lining” in which I predicted:

• 1) Stock market crash due to over-valuation

• 2) Credit crunch due to excessive personal and corporate debt

• 3) The third oil shock

• 4) A resurgence of inflation

• 5) Foreign military and/or financial crises in an increasingly unstable global

• economy

• 6) Devaluation of the dollar due to record trade deficits

• 7) The Y2K problem, which I dismissed as "trivial"
  

As Leonid Kondratieff revealed in his groundbreaking "The Major Economic Cycles" (1925), these long-wave Megacycles have a two-stage denouement — in other words, two crashes/recessions. For example, in Europe the Industrial revolution was punctuated by the French Revolution and the Napoleonic Wars between the waning agricultural society of France and the rising industrial societies of Britain and Germany. In the US there was the crash/depression of 1837 followed by the same in the 1850s, followed by the Civil War (marking the transition to the Industrial Revolution whereby the waning agricultural South was vanquished by the ascendant industrial North). Worldwide, we had crashes/recessions preceding World Wars I and II, marking the transition to the Petro-Industrial Revolution in which the waning traditional industrial economies of Germany, Japan and England were superseded by the rising petro-industrial economy of the U.S., and more recently we’ve had the crashes and recessions of 2001 and 2007-2009 accompanied by wars in the Middle East marking the transition to the Electronic Revolution.

Whether these represent the two stages of the Phase II of the current Megacycle, or whether these should be regarded collectively as the first stage with another stage to follow (with the ascendant Chinese economy striving to supplant a waning petro-industrial U.S. economy) is the great imponderable of our times -- complicated enormously by the Clash of Civilizations between two traditionally hostile religions economically polarized by conflicting interests over oil. My suspicion, given the current U.S. political and economic disarray in the face of unconscionable inequality of wealth, the ongoing confrontation between the West and the Middle East over oil, and the relentless ambitions of China, is that the second stage and its associated calamities are still ahead of us.
 
Stalin executed Kondratieff for including in his Long-Wave Theory the notion that capitalist economies exhibited remarkable recuperative powers following their periodic financial/economic meltdowns, contradicting communist dogma positing the ultimate demise of capitalism. While history favors Kondratieff's view, not Stalin's, enlightened U.S. and, indeed, world leadership will be required avert looming catastrophes. Unfortunately, as the late Senator Everett Dirksen used to say, "Washington can't manage a crisis until it becomes one." So hope for the best and prepare for the worst. 

For more on this theme, look for the second edition of The Predicament, available in e-book format on Amazon and other e-book sellers in about a month and the print edition to follow in mid-April 2013.


David L. Smith
Editor and Publisher
Cyclical Investing and David L. Smith's Cassandra Chronicles
Author: The Predicament (www.the-predicament.com)