The specter of financial socialism

The specter of financial socialism is haunting global financial markets. Where free markets and the magic of the invisible hand were always the fundamental pride and strongest weapons of the United States in the fight against communism, America now appears to have abandoned its core principles and is leading the charge toward financial socialism. The role of government in America’s economy is surging and the bigger it gets, the lower the credibility of free market capitalism gets around the globe.

One of the greatest enemies of capitalism of all time, Vladimir Iiyich Lenin, said: “There are decades when nothing happens; and there are weeks when decades happen.” In America, this is exactly what occurred.

Last month, the U.S. budget deficit — $864 billion — was larger in one single month than the cumulative total debt taken out in the first two centuries after its founding: 1776 through 1979. Relative to the size of the current GDP, the explosion of government debt is also unprecedented. Most forecasters are now expecting the fiscal deficit to run at around 20 percent of GDP in 2020, up more than five-fold from the 4.7 percent reported last year.

Mobilization of public resources at this scale historically happens only during wartime, and there is strong symbolism in the fact that sometime next year U.S. total federal debt outstanding is expected to exceed the record 112 percent of GDP reported at the end of World War II. From an economist perspective, COVID-19 has triggered a shift toward a central-command wartime economy.

Of course, the U.S. Federal Reserve has acted in complete lock-step coordination with the U.S. Treasury. Interest rates were effectively cut to zero and quantitative easing was turbo-charged. Total central bank assets exploded from $4.2 trillion at the end of February to $7.2 trillion by the end of June. This year’s $3 trillion jump in the Fed’s asset base is almost three times larger than the $1.2 trillion jump engineered during the global financial crisis following the 2008 collapse of Lehman Brothers. To put it in perspective, the Fed’s balance sheet is now approximately 33 percent of U.S. GDP. This is more than 10 times higher than the levels deemed “normal” before the global financial crisis. Again this amount of central bank involvement in a national economy is typically only found during war.

Importantly, the 2020 crisis response by the Fed did not just follow the “Lehman shock” script. Spurred on by U.S. Treasury Secretary Steven Mnuchin, the Fed significantly expanded the scope of financial markets that it’s interfering with.

While previous interventions were limited to U.S. government debt and acting as lender of last resort to banks, the Fed now has intruded into basically all major markets. It stepped into the corporate bond market to buy corporate debt all the way up to junk bonds. It provided funding to the repo markets (where treasuries are swapped for overnight cash for private institutions). It provided liquidity to money market mutual funds. And it directly bought mortgage-backed securities. The only market not directly touched by Fed interference has been the equity market.

Still, the total amount of promised and possible Fed intervention in U.S. private credit markets is stunning: The Fed is ready to buy as much as $4 trillion in all U.S. credit markets, which have a total outstanding of approximately $25 trillion (estimates by The Economist). In short, the central bank is now prepared to buy up to approximately 16 percent of all U.S. private credit.

Now remember there is a huge difference between the central bank buying treasuries and privately credit like corporate bonds or mortgages or repos. The former are issued by the people through their elected government, and pay for public services and public investments. The latter is borrowings by private companies who are in it for the money. How the unelected officials of the Fed decide which particular bonds to buy is as much of a mystery as smoky backroom decision-making was in the Kremlin during the heyday of the Cold War.

The whole point of having private capital markets is to let private investors make their own free decisions on which companies and projects to finance — unperturbed by government dictate, expert group top-down orders or self-serving authoritarian muscle. In the aftermath of the 2001 terror attacks on the World Trade Center, the mayor of New York was asked: “What can New Yorkers do?” His response was “go shopping.” This was an encouragement for consumers to help, out of free choice, get the economic cycle going again. Now, the Fed is not just saying “go shopping” but also “if you don’t go buy these bonds, we’ll buy them and thus drive up the price.” All this, of course, in the name of saving capitalism from itself.

From a Japanese perspective, all of this looks very familiar. While bigger and faster, the overall thrust of the U.S. financial counter policy to the COVID-19 crisis follows the very same script laid out by the Finance Ministry and the Bank of Japan over the past decade. The BOJ effectively owns about half of the treasury debt, approximately one-third of corporate bonds and is on track to own about 10 percent of the stock market by next year. For all intends and purposes, Japan invented financial socialism. Now the U.S. is perfecting and up-scaling it.

In my view, we must be grateful for the swift and decisive actions taken by the U.S. Without it, the world would be in a much worse state. The U.S. shift toward a de-facto wartime economy with extreme government intervention saved us from an almost certain depression. So so far, so good. However, sooner or later the exit problem will have to be solved.

I started with a quote from Lenin, the greatest foe of capitalism, so let me conclude with Milton Friedman, the greatest advocate of free-market capitalism: “Nothing is as permanent as a temporary government program.” Funded by its newfound financial socialism, approximately 72 percent of Americans are now directly dependent or indirectly on public support and government transfers for the majority of their economic livelihood (indirectly as their place of employment depends on public support or government business). This is more than double the pre-COVID-19 “normal.”

More to the point: For their economic livelihood and well-being, Americans are now at least as dependent on central government benevolence and wisdom than the Chinese are. No wonder the Chinese Communist leadership is getting more and more confident in the superiority of its socialist vision.

It will be interesting to watch how America will try to get back to its foundational ideas of empowering private enterprises, private risk-taking and true self-determination. The world needs a strong and confident narrative of free-market capitalism and liberal democracy more than ever. I sure hope the American Dream can make a comeback and kick out the specter of financial socialism before it turns from a bad dream to a permanent reality.

Jesper Koll, a Japan strategist/economist, is a senior adviser to Wisdomtree Investments. He blogs at

www.wisdomtree.com/blog.