Capital Strike Redux?

After the US economy began to recover rather robustly in the mid-1930s, a series of ill-considered government policies, notably a tax on undistributed profits, a big increase in marginal rates on high incomes, the Wagner Act, and a Fed contraction of the money supply led to a substantial contraction in 1937.  The depression within the Depression.

One notable feature of the 1937 episode was the so-called “Capital Strike”, a sharp decline in corporate investment.

The imminency of Obamacare and Frankendodd, and the continued failure to address seriously the country’s fiscal situation, with the associated uncertainty about taxes and spending, may be creating a modern-day version of the capital strike.  The WSJ reports that growth in investment expenditure has slowed to a standstill, and that many large companies are slashing investment plans.  The article places the blame on the “Fiscal Cliff”, but in reality, this is overdetermined, as they say.  There are multiple factors at work, and all in the same bearish direction: the regulatory friction (epitomized by Obamacare, Frankendodd and the EPA) is a major drag on growth, and a major source of investment-killing uncertainty.  Indeed, I would put the least weight on the Fiscal Cliff as it is conventionally portrayed: that conventional portrayal is almost purely comic book Keynesian in nature, focusing on “aggregate demand”.  IMO, the handling of the expiration of various tax reductions and the potential for sequestration is relevant not because of AD-a slippery and largely chimerical concept-but because of what it portends about the future course of government spending, and in particular the appetite to deal with entitlements and transfer payments.

If what the WSJ reports is indeed a harbinger of a modern day capital strike, that would be consistent with my broad forecast in my post-election post.  A protracted period of stagnation/slow growth.  Which will only exacerbate the fiscal situation and increase the risk of a rollover/funding crisis.

As if we really should need another Ghost of Christmas Future to warn us, take a look at Japan right now.  Just saying.

About Craig Pirrong 228 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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