by James A. Bacon

Of all known government interventions in the U.S. economy, the most insidious and dangerous is regulation of the price of money (interest rates). Years of Federal Reserve Bank monetary stimulus and quantitative easing, promulgated for the purpose of easing or avoiding a recession, is wrecking the U.S. economy in ways that are only dimly understood. In the most important essay you can read this month — perhaps this year — Ruchir Sharma, chief global strategist for Morgan Stanley Investment Management, shines light on the problem in a Wall Street Journal op-ed, “The Rescues Ruining Capitalism.”

The op-ed is must reading for anyone who seeks to understand the direction of the national economy, and is vital even for readers with a Virginia-centric viewpoint because if the U.S. economy falls victim to declining productivity, slower economic growth, and aggravated income inequality, so, too, will Virginia’s. If economic growth stagnates, we must make commensurate adjustments to our budgetary and policy aspirations here in the Old Dominion — which our local political class shows no inclination to do.

Here follows a Reader’s Digest-like condensation of Sharma’s key points, with occasional interpolations.

A growing body of research shows that constant government stimulus has been a major contributor to many of modern capitalism’s most glaring ills. Easy money fuels the rise of giant firms and, along with crisis bailouts, keeps alive heavily indebted “zombie” firms at the expense of startups, which typically drive innovation. All of this leads to low productivity — the prime contributor to the slowdown in economic growth and a shrinking of the pie for everyone.

At the same time, easy money has juiced up the value of stocks, bonds and other financial assets, which benefits mainly the rich, inflaming social resentment over growing inequalities in income and wealth. … The rising culture of government dependence is, in fact, a form of socialism — for the rich and powerful. …

In 2008 the Treasury stepped in to save an entire sector — banks at the core of the mortgage crisis — with $200 billion. Unable to do much more to cut rates, which were already close to zero, the Fed launched its first experiments in “quantitative easing,” buying up tens of billions of dollars in assets each day, including mortgage-backed securities, to calm the credit markets. The rest of the world followed the Fed. …

In the 2010s, as easy money continued to flow from central banks, the global economy staged a recovery that was unusual for its length but also for its frustratingly slow pace of growth and for how few nations were allowed to suffer a moment’s pain. …

As governments stepped in to do whatever it took to eliminate recessions, downturns no longer purged the economy of inefficient companies, and recoveries have proven weaker and weaker, with lower productivity growth. …

After the global financial crisis of 2008, households and financial firms in many capitalist countries felt pressure to restrain their borrowing. Governments did not. The world’s total debt burden plateaued at a historic high of 320% of global GDP by the end of 2018, but within that total, government debt rose most rapidly. …

The idea of government as the balm for all crises is appealing the short term, but it ignores the unintended consequences. Without entrepreneurial risk and creative destruction, capitalism doesn’t work. (My emphasis. JAB) Disruption and regeneration, the heart of the system, grind to a halt. The deadwood never falls from the tree. The green shoots are nipped in the bud.

Low rates give big companies a strategic incentive to grow even bigger, in large part because securing a dominant position in the market promises outsize financial rewards.

Here I would interject to mention a book by French economist Thomas Philippon, “The Great Reversal: How America Gave Up on Free Markets,” which documents this very trend. His thesis is that over the past 20 years or so, American industries are increasingly dominated by fewer, larger corporations that exercise greater market power. Reduced competition leads to slower productivity growth, less innovation, and greater inequality of wealth. Now, back to our regularly scheduled programming…

As the large grew increasingly entrenched, they sucked up talent and resources, crowding out the little guys. Startups represent a declining share of all companies in the U.S. and many other industrialized economies.  Before the pandemic, the U.S. was generating startups — and shutting down established companies — at the slowest rates since at least the 1970s. The number of publicly traded U.S. companies had fallen by nearly half, to around 4,400, since the peak in 1996. And many of them started running up massive debts, in part as a desperate effort to grow in the shadow of the giants.

Today an astonishing number of the survivors are, quite literally, creatures of credit. In the 1980s, only 2% of publicly traded companies in the U.S. were considered “Zombies,” a term used by the Bank for International Settlements (BIS) for companies that, over the previous three years, had not earned enough profit to make even the interest payments on their debt. The zombie minority started to grow rapidly in the early 2000s, and by the eve of the pandemic accounted  for 19% of U.S.-listed companies. …

With every crisis, more of these creatures of debt survive. … Each new U.S. recession has been met with more bailouts and easy money, leading to a lower rate of corporate defaults. Over the last 20 years, the falling default rate has also closely mirrored the slowdown in U.S. productivity. … “Zombie congestion” in any industry lowers the productivity of rival companies — and blocks the entry of new companies — by raising labor costs and making it difficult to attract capital. …

The question is how much further capitalism will be deformed by government intervention on this scale. When government is willing to buy just about anything, it distorts market prices, which normally guide people to buy into profitable, promising companies. Now investors are simply buying what the Fed buys. The process of competitive capital allocation, which is critical to raising productivity, has broken down. …

Governments need to recognize that constant intervention to prop up the economy and financial markets is not achieving its intended purpose. After 2008, the Fed and the Treasury were praised to the moon for “saving the world,” but the Fed’s “experimental” forays into quantitative easy continued long after the crisis was over. … Its interventions are doing more to boost the stock market than the real economy. … Easy money is … inflating stock and bond prices, encouraging inefficient firms to take on more debt, and seeding financial instability.

Unless the Fed drastically shifts course — at the expense of considerable pain, analogous to the sharp “Volker recession” that broke the back of inflation in the 1970s and early ’80s — the United States can look forward to increasingly concentrated industries dominated by fewer big companies, more debt-ridden zombie companies, lower productivity growth, less innovation, slower wage growth, and a host of other ills. Sadly there is no sign that America’s political class — much less our president, who has agitated for more cheap, easy  money — is remotely aware of the damage that Fed policy is doing to the economy. Without such awareness, there is zero chance of that policy changing.

In the past, I’ve found consolation in the thought that, although federal fiscal and monetary policy was careening toward disaster, Virginia remained an oasis of economic stability and soundly managed government. As I look around me, I no longer find comfort in my Virginia citizenship. We are fast becoming New Jersey. We are sprinters in the race to the bottom.