Greenspan Conundrum And How The Rich Get Richer And The Poor Spend Most Of Their Money

Plea for a New World Economic Order.

Chapter I: Greenspan Conundrum and Income/Wealth Disparities.

“The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author’s assault upon them is to be successful, -a struggle of escape from habitual modes of thought and expression.

The ideas which are here expressed so laboriously are extremely simple and should be obvious.

The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

John Maynard Keynes, 1st Baron Keynes of Tilton
(5 June 1883 - 21 April 1946)
The General Theory of Employment, Interest, and Money,
Preface.
13 December 1935

Abstract:

This paper shows that interest rates are the cause and consequences of the explosion of income/wealth disparities, the first order hidden variable, possibly the only one, of economic development and the root cause of Keynes’ Liquidity Trap and of the present economic crisis.

It solves the famous Greenspan Conundrum.

Long-Term Behaviour of Interest Rates:

As we can see on the following charts long-term interest rate are following a secular downward trend since 1981.

“There is little doubt that, with the breakup of the Soviet Union and the integration of China and India into the global trading market, more of the world’s productive capacity is being tapped to satisfy global demands for goods and services.

Concurrently, greater integration of financial markets has meant that a larger share of the world’s pool of savings is being deployed in cross-border financing of investment. The favourable inflation performance across a broad range of countries resulting from enlarged global goods, services and financial capacity has doubtless contributed to expectations of lower inflation in the years ahead and lower inflation risk premiums.

But none of this is new and hence it is difficult to attribute the long-term interest rate declines of the last nine months to glacially increasing globalization. For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.

Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.”

Chairman Alan Greenspan
Federal Reserve Board’s semiannual Monetary Policy Report to the Congress
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
February 16, 2005

Keynes’ Liquidity Trap:

Keynes Liquidity Trap occurs when, and that is a departure from the classical definition, the yield curve is inverted, people withdraw from holding long-term assets if the short-term interest rates reached 0% monetary authority have no way of enticing people to invest long-term. Because these investments are central to money creation in a Capitalist economy it causes its systemic collapse.

Hence we define the yield curve of Keynes Liquidity Trap as the normal yield curve that goes through (0, 0.00%). As with any normal yield curve, the higher the volatility, the steeper the curve and the higher the long-term rates (confer Chapter II).

We have proved that the Markets can have protracted periods of inverted yield curve. So the effective yield curve can be for some time below the Keynes’ Liquidity Trap yield curve.

When in normal time I=S (Investments=Savings), in a Liquidity Trap S stays higher or even grows. I dwindles to 0 and so does the demand for good and services. Savings stay in liquid assets and are therefore not invested on long-term assets.

The minimum rate at which the capital market is ready to supply is greater than the rate of the demand for investment. The market does not clear by lowering the long-term rates.

Expecting that market forces will solve the problem is simply hilarious: there is no market.

If money is the blood of an economy, in a capitalist economy the credit market is its heart.

Mechanism of a Depression:

We have seen that the Depression starts with a disruption of capital markets which stop to clear. What is interesting is to understand why it won’t adjust. In a normal crisis assets and investments lose value so their return increase and there is a new equilibrium. In the case of the Liquidity Trap because of the break down of the financial system the demand goes down at the same rate or even faster that the value of assets so the return on investment never goes up to the minimum yield on long-term savings.

Hence the cause of the Liquidity Trap and hence of all the present economic turmoil resides in the fall of long-term interest rates.

In order to understand the root of the crisis we need to understand the cause of that trend.

Income / Wealth Distribution Does Matter:

One of the premises of economist regarding the Capitalist system is that income / wealth distribution does not matter. And that income repartition is optimal when left to the Market. This is so true that all the economic aggregates that are published are averages never standard deviations.
Monetarist theory takes the money supply as one without recognizing that what one does with his money varies with his income and his wealth.

Usage of Money:

The Rich:

The use of marginal revenue by the rich goes almost 100% to savings his propensity to save is close to 1 his propensity to consume is close to 0. In a normal economy nearly all of these savings are channeled into long term investments in fact globally only the bank reserves are liquidity that are not funneled into investment.

The Poor:

The usage of his marginal revenue is completely different. Any money he receives goes to consumption. His propensity to save is close to 0 his propensity to consume is close to 1.

Credit:

Because of the existence of credit income wealth disparities keep increasing:

Discrimination and Class Struggle:

Credit market discriminates against the poor: the richer you are the most credit you can have and the more profit you can generate. If you are poorer you get higher rate, a lower amount of credit and most of the time it is geared to consumption and not investments the credit you get makes you poorer. If you are even poorer than that you will not be even given the advantage of saying hello to your banker. This what they call equal opportunity, we suppose.

Where it shows that it is a class struggle is that according to your wealth you pay a risk premium. The poorer you are the higher the risk premium.

Who pays that risk premium? Those who do repay their credit. Obviously those who don’t do not pay their risk premium. So this risk premia are tantamount to a collective punishment that only the best pupils of the class will have to endure.

Credit market goes against anything that a democratic and capitalist society pretends to defend.

Income Wealth Disparity:

In a capitalist society capital is the most important factor of production. With it you can buy all other factors of production. If you have no access to credit free enterprise is and stays a dream. With credit the notion of equal opportunity is the biggest lie man has invented and believed in. The American Dream is for 80% of the population a nightmare.

The poor gets poorer because not only they can’t invest but also their bargaining position is weak when it comes to wage and salaries (the more options you have the stronger you are).

“The income gap between the rich and the rest of the US population has become so wide, and is growing so fast, that it might eventually threaten the stability of democratic capitalism itself.”

Chairman Alan Greenspan
The Economic Outlook
Before the Joint Economic Committee, U.S. Congress
June 9, 2005

Long-Term Interest Rates:

As the rich get richer and the poor relatively poorer the marginal supply of money invested increases and the production increases while at the same time the marginal demand for these production decreases. The Market adjust by decreasing the yield of investments and hence the yield on bonds. As the disparities go up and accelerate so does the fall of long-term interest rates. Karl Marx capitalist accumulation is the explanation of the Alan Greenspan Conundrum and Benjamin Shalom Bernanke Saving Glut.

The Solution of the Greenspan Conundrum or Bernanke Savings Glut:

Credit Is the Cause and Consequence of the Explosion of Income / Wealth Disparity and of The Future Systemic collapse of the Economy Through Keynes’ Liquidity Trap.

All of This Stays True Until the Poor Becomes Richer Relatively to the Rich.

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