end game (ii): Keynes, Kondratiev and Schumpeter

The nineteenth century in Europe ushered in a deep change in the metaphor used to explain how the world works. The earlier (Enlightenment) view was that the universe was like a magnificent watch, made in the dim past and kept running by God, the ultimate craftsman. What you see is what you get.

By 1820, the metaphor was already moving quickly from mechanical to biological–evolution; conflict, sometimes violent, driving the process; the unconscious nature of much of what happens, both on an individual and a social level.

Yes, more stuff changes in the 20th century, but what’s important for us as investors is that these are creative fictions created to explain the world of 200 years ago continue to live in economic theory.

cast of characters

The nineteenth-century thoughts enter 20th century economics in a number of ways:

–Nikolai Kondratiev (1892 – 1938). His take on Hegel, formulated in the 1920s, was that the western world follows a 40- 60-year economic cycle. The first half exhibits robust growth. That’s followed, however, by a secular decline and, at least in the version I learned as a young analyst, the destruction of existing production apparatus through world war. Rebuilding from the rubble would start a new long cycle in motion. Some Kondratiev theorists also suggest there’s also a “super” Kondratiev cycle lasting a century+, the high point of which was reached in rebuilding from WWII. (In other words, my whole life would be on the downslope. Very depressing)

–Joseph Schumpeter (1883 – 1950). His version of Hegel is “creative destruction.” In his view, entrepreneurs ultimately use loose credit as a way of continually expanding their businesses to the point where supply of goods/services completely outstrips demand. This causes severe recession–a mini-Kondratiev experience. But like a phoenix rising from the ashes, a new upcycle emerges from the destruction of the old.

In both these cases–as with Marx–the precondition of the new cycle starting is the utter collapse of the old. Recessions are bad, but the cleansing they do is important for progress to happen.

–John Maynard Keynes (1883-1946). Keynes’ interest was more practical, and perhaps more modest, than his Continental contemporaries’. His main focus was on the Great Depression of the 1930s and how to prevent a recurrence. In other words, his intent was to use monetary and fiscal policy to forestall the economic peaks and valleys that the others thought was the inevitable price to be paid for evolutionary progress.

relevance for today’s stock market

A preliminary point: Trump’s incompetence in office, both before the pandemic (his tariff and immigration policies had reduced real GDP growth from 2%-ish when he took office to near zero), and especially during it, is the main reason the US is in so much worse economic shape than other OECD countries. Getting him out of office would seem to me to be the #1 economic goal for the country.

The nearer-term question is whether Washington should go all in with fiscal support to blunt the negative effect of the pandemic on the domestic economy. Here’s where the clash of economic theories comes in (as well as another Trump blunder).

Conventional economics, represented by Keynes, argues that stopping the economic bleeding is the top priority. Among Trump’s financial backers, especially on Wall Street, however, Kondratiev/Shumpeter seems to me to be the prevailing view. I think the idea that greater destruction now will lead to better growth later is why the Senate is balking at providing further financial support.

What complicates the issue somewhat is Trump’s income tax “reform” enacted in 2017. That bill did a good thing by reducing the highest corporate tax rate from 35% (highest in the world) to 21%–something that was necessary to stem the flood of US companies fleeing to lower tax-rate regimes. But it did harm by failing to offset that loss by eliminating special interest tax breaks, and it lowered personal income taxes for the ultra-wealthy. The result was a $1 trillion federal deficit expected for this year, pre-pandemic. As things stand now, the deficit will likely hit $4 trillion.

Under Trump, the national debt has already increased by almost $7 trillion, to around $27 trillion, making the US one of the most indebted countries in the world. At some point, creditors will begin to worry that the country will not be able to repay. In the signature fashion that led to his companies’ multiple bankruptcies, Trump made this situation worse by suggesting the US is willing to default on debt held by foreigners. Typically, worry shows itself first of all in currency weakness of the type the dollar has seen over the past few months.

my take

First of all, you should realize I’m really out of my comfort zone with the politics here. For what it’s worth, though, I think the Kondratiev/Schumpeter crowd believes that withholding government help and letting people fend for themselves is conceptually the right move. This group seems to have the ear of Senate Republicans. The fact that their personal wealth will suffer most severely from currency weakness probably colors their thinking as well. Trump says he’s in favor of more government aid and could probably persuade Republican senators to change their minds. But he chooses not to.

So we’re kind of in no man’s land. I think this means that we’ll remain in the current “capital flight” stock market, no matter how long in the tooth it appears, for a while yet.

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