Capitalism has delivered prosperity, and countries that adopt the principles of free markets and enterprise are more prosperous. Witness the countries of the former Eastern Bloc. However it would be disingenuous to say everyone at all times benefit from capitalism. It does suffer from crises and the Great Financial Crash (GFC) in 2008 may be described as one. However is the response to the GFC making things worse for capitalism in the long run? And what does that mean for all of us and our livelihoods?
Post the GFC of 2008, central banks embraced the concept of Quantitative Easing (QE). The term QE has quickly entered our financial vocabulary, but what does it actually do and mean? QE may be simply described as the “printing” of money by central banks. Interest rates have been cut to record low levels (and may be cut further) and the banks were rescued and recapitalised to maintain their ability to lend. The aim of QE was to generate economic recovery post the GFC and stop collapsing demand and the spectre of deflation, where continuously falling prices lead to a spiral of falling demand. The result meant the banks did not go bust, unemployment did not rocket and the share market enjoyed a “bull” run of rising share prices.
However, did QE store up greater long term problems? Has “creative destruction”, an essential part of capitalism been suppressed? The economist Joseph Schumpeter coined the term “creative destruction” to describe the process by which capitalist economies continuously innovate and replace outdated products and processes. Thus the free market is able to deliver progress and rising living standards. There are numerous examples of the above process; the rise of the car replaced the carriage and spawned the rise of tourism, new delivery chains grew, and the shape and form of cities began to change. However there were causalities in particular the carriage makes and the number of blacksmiths. More modern examples abound; the internet is rapidly replacing the daily newspaper, cassettes have been replaced by compact discs and again by music downloads. And showing my age, the slide-rule was replaced by the calculator. (Look up slide-rule on the internet, it was no fun!) Overall such a process raises living standards and productivity.
But in propping up the economy, has QE stopped/delayed the creative destruction process? Take what are called “zombie companies”. They are companies that are just surviving. Usually they are heavily indebted, barely covering interest payments, let alone actually having the capacity to pay off the debts. They have no cash to grow, their productivity is stagnant as they cannot invest or increase wages. But, without QE, such companies would have gone bust.
Eventually interest rates will rise (although the date is continuously being pushed out) and such companies may well go bust. Although torrid for the shareholders, creditors and employees of such companies, this is all part of the “creative destruction” within capitalism. But out of the rubble will come new companies and products that improve on the past. It’s then that long term forces of capitalism can be re-established and capital and resources allocated to those industries that will provide the new round of wealth and prosperity. Until we come off the drip feed of QE, economies may be faced with a prolonged period of low and anaemic growth, which may well be described as a “crisis of capitalism”.
The above article by Simon Brett, Director & Chief Investment Officer at Parmenion Investment Management, was first published by Parmenion Investment Management on 10th August 2016