The theory of the so called wealth effect, which is also behind the argument for “trickle down economics”, is that, as people feel “wealthier”, as a result of the money price of their assets rising, they spend more money, and this increases aggregate demand in the economy, creating more jobs and so on. It is nonsense. What inflated asset prices did was to create a speculative fervour, so that rather than encouraging higher levels of consumer spending, they encouraged consumers to divert spending on consumption to spending on the purchase of assets for fear of missing out. In the case of housing, it led to rampant borrowing, both to be able to afford astronomically high house prices, and, in stimulating monetary demand for those houses, acted to create and further inflate those astronomically high prices. Its most obvious conclusion was the creation of the sub-prime mortgage crisis, in 2008, that provided a spark for the global financial crisis.
But, it was not just consumers that diverted revenues to such speculation, and away from consumption. Companies did that too, encouraged by their boards of Directors, acting in the interests of shareholders rather than the company. They diverted profits away from capital accumulation, with share issuance being curtailed, but actively used profits to buy back shares, so as to raise their prices. They even borrowed money, via bond issuance, so as to buy back shares, and inflate share prices. That increased bond issuance, of course, would have caused bond prices to fall, and yields (rate of interest on the bond) to rise, except that the state created conditions for these additional bonds to be bought up in even greater quantity.
Pension funds were required to buy bonds, the state, implementing fiscal austerity, issued proportionately fewer bonds, as it sought to reduce its debt (with the new contradiction then being that, as austerity curtailed growth, the share of debt to GDP still rose). The most obvious policy in this regard was QE, whereby, central banks simply printed additional money tokens, and used them to buy up bonds, to inflate their price, as well as making cheap credit available to commercial banks and finance houses, to encourage them to buy up bonds, and so inflate their price. The activity of banks became not to finance real economic activity, but to finance this rampant speculation and gambling.
Again, far from stimulating economic growth, it did the opposite, particularly when combined with fiscal austerity, specifically designed to reduce economic growth! By inflating asset prices, money that consumers had went to buy houses whose prices had risen phenomenally. The higher house prices, driven by this speculation, led to higher land prices, which meant the cost of building new houses rose significantly too. Where after WWII, the cost of land accounted for 10% of the cost of a new house, now, it accounts for 70%, with a consequent huge rise in the total cost of the house, after the average profit is added. Of itself, that represents a significant shift of the supply curve for houses to the left, reducing supply whatever appeals governments might make for builders to increase supply. In turn, that constrained supply, with rising monetary demand from speculation, causes prices to rise further.
Higher house prices, making it impossible for many younger people to buy, leads to rising demand for rental property. But, Thatcher sold council houses in the 1980's, and effectively prevented councils building more, a policy continued in the 1990's, and then by Blair and Brown. That acted to fuel house prices even further, but, also, forcing renters into the hands of private landlords led to a huge rise in rents. To sustain those higher rents, as wages were constrained, the state was led to introduce ever rising levels of subsidy, such as Housing Benefit. But, to pay for those subsidies, going straight into the pocket of landlords, higher taxes are required, acting as yet a further drain on profits that could otherwise have been used to finance capital accumulation, and real economic growth. Similar patterns occurred across Europe and North America.
Higher share and bond prices, meant that fewer of them could be bought by the monthly pension contributions of workers and employers. That raised the cost of pension provision, meaning a further drain on profits, as higher contributions are required to sustain the same level of purchases. But, in fact, contributions were not increased, leading to the current huge black holes in pension funds, which, then have to be filled by the state, requiring again increased taxes and drain on profits. In fact, in the 1990's, and early 2000's, as asset prices rose sharply, many employers reduced or even suspended contributions into pension schemes on the basis that their immediate pension liabilities could be met by simply selling some of the shares/bonds in the fund, and using the proceeds, rather than using the revenues from those assets for that purpose. That further contributed to the black holes in those funds, as it reduced the real capital base of the fund, disguised by the inflated prices.
This summed up the model of conservative social-democracy during that period, a model that was doomed to failure, and to create a huge crisis, as it did so. The model is that of the farmer who, tries to maintain or increase their consumption of grain, by utilising an increasing proportion of their grain output for that purpose, and so a smaller proportion of it to be put back in the ground as seed. It is the same kind of model as that of the Ponzi Scheme, or of Bernie Madoff, but applied to the whole of the economy.
As with Madoff, when it all collapsed in 2008, or like a farmer, who eventually finds that they have consumed so much of their seed corn that they can't get enough seed to sustain even their current levels of output, so conservative social-democracy found that its model was no longer sustainable. Unlike Madoff, however, social-democracy has the advantage of control of the state, and so, in 2008, it was able to bail out the ruling class, by having the state buy up all of those, now, worthless paper assets. It could do so by telling the working masses that, although they had not been the beneficiaries of those astronomically inflated asset prices, they would, now, have to pay the cost of those prices having collapsed, and need to bail-out the ruling class speculators.
They would have to pay for it by having a ten year period of fiscal austerity, during which basic public services, provided by state-capitalism, would be left to fall into a state of near collapse, be it of healthcare, or simply the fabric of roads, and schools. In the meantime, their taxes would rise, reducing real wages, and their money wages, particularly if they worked for the state, would be held down, or even reduced, their pensions cut, and they would be required to work for much longer, before they could even retire.
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