This is the third installment in a seven-part series running throughout the week. Read the first and second parts.

Pension Fund Finance Capitalism

Finance capitalism took a great leap forward in the 1950s with the innovation of pension fund capitalism, which Peter Drucker went so far as to applaud as “pension fund socialism.” The idea was to set aside part of the wage bill for professional money managers on Wall Street to invest in the stock and bond markets. General Motors and other companies described this as giving labor a stake in industrial capitalism, by turning them capitalist in miniature.

Equities are indeed ownership shares. But they do not give labor much voice in management, even for workplace conditions or other employment practices. The situation is similar to that which prompted minority New York Yankees baseball investor John McMullen to complain: “There is nothing in life quite so limited as being a limited partner of [managing partner] George Steinbrenner.” If managers lay off workers or use cash flow for stock buybacks or higher dividend payouts rather than for new direct investment and hiring, labor is supposed to see itself benefiting as a financial investor.

Pensions could have been organized in a variety of ways. Public pensions could have been paid out of the general budget’s progressive income taxation, as in Germany’s pay-as- you-go system. At the other end of the spectrum, Employee Stock Ownership Plans (ESOPs) gave workers stock in their employers. These plans ran the danger of being wiped out in bankruptcy or mergers.

This ploy was refined most notoriously in Chile after 1973 under General Pinochet. Recently at the Chicago Tribune, real estate magnate Sam Zell used the company’s ESOP to pay off his creditors, leaving a bankrupt shell and an impending set of lawsuits.

None of the above plans gave workers managerial positions on the corporate boards, as in Germany. Instead of being spent on the consumer goods that labor was producing, payments to pension funds were spent on stocks and bonds. What Pinochet (to be echoed by his admirer Margaret Thatcher in Britain) would call “labor capitalism” was more accurately “labor finance capitalism.” Pension contributions were invested in financial markets, pushing up asset prices. The valuation of wealth rose—real estate, stocks and bonds—relative to labor’s wages and salaries.

This proved a boon for managers and venture capitalists exercising their stock options. These insiders sold, and pension funds bought. The rising inflow of funding inspired dreams that pensions could be paid out of capital gains rising exponentially. By the time the dot.com bubble got underway in the 1990s, a rate of 8 percent compounded annually was almost universally projected. Any given amount would double every nine years and quadruple in eighteen to pay much larger future pensions. Soon, the only way to keep pension plans solvent at given “defined contribution” rates was for their investments to keep on expanding at this unsustainably high rate.

The only way to achieve this return even for a short while was for the Federal Reserve to flood the economy with credit—that is, with debt. So pension fund finance capitalism became dependent on the bubble economy orchestrated by Federal Reserve Chairman Alan Greenspan and continued by his successor, Ben Bernanke, to lower interest rates steadily down through 2012, capitalizing corporate profits and real estate rents into bank loans at rising multiples.

According to the rosy textbook pictures, the stock market is supposed to raise funding for industry. But stock ownership itself was being decoupled from management, just as the financial sector was becoming independent of tangible capital formation. As pension funds became part of the financial sector, they played a major role in the leveraged buyouts that loaded down companies with junk-bond debt.

Confronted by Michael Milken at Drexel Burnham cheerleading from the 1980s onward, healthy companies were obliged to defend themselves by taking “poison pills,” going so deeply into debt so that raiders could not take on any more to buy them. Some companies used their cash flow and even borrowed to buy up their stock so as to raise its price by enough to leave less revenue available for prospective raiders to pay their bankers and bondholders.

Fiat Money Based on America's Militarized Balance-of-Payments Deficit

To understand what made the bubble economy’s credit wave possible, it is necessary to understand how the international financial system was transformed in 1971 when overseas military spending forced the U.S. dollar off gold. The metal was a pure asset, earned by running balance-of payments surpluses—and sold off by running trade and payments deficits. President Nixon’s suspension of gold sales through the London Gold Pool left the world’s central banks without a means of settling their balance-of-payments deficits (James Steuart called gold “the money of the world” in 1767), except to use what had become a proxy for gold: US Treasury bonds.

These government IOUs were supplied by the US economy running a balance-of- payments deficit. Ever since the Korean War broke out in 1950, this deficit stemmed entirely from military spending. US trade and private-sector investment were in balance, and what was called “foreign aid” actually generated a payments inflow (being tied to the purchase of US exports). So the dollars that ended up as global central bank reserves were the embodiment of America’s military spending. (I describe its dynamics in my 1972 book, Super Imperialism.)

Removal of gold as an international constraint meant that the larger the U.S. payments deficit grows, the more dollars end up in the hands of foreign central banks—which have had little alternative but to recycle them to the U.S. economy by buying Treasury bonds. The balance- of-payments deficit thus has become the means of financing the government’s domestic budget deficit.

The link between the dollarized global monetary system and military force became explicit after the Organization of the Petroleum Exporting Countries (OPEC) quadrupled its oil prices in 1973-74 in response to the U.S. quadrupling of grain prices. Treasury officials met with Saudi Arabian and other OPEC officials and explained that they could charge as much as they wished for oil (which provided a price umbrella for US oil companies to make windfall “resource rent” profits), as long as they agreed to hold their reserves in U.S. Treasury bonds or otherwise recycle their export earnings into the U.S. economy—by buying stocks, real estate and other property claims, but not ownership of strategic industries.

U.S. economic strategists soon came to realize that American investors could buy up foreign assets without limit, while consumers also imported more. Running up foreign debt created a proportional inflow of funds to buy Treasury bonds. This reversed the traditional impact of trade and payments deficits on interest rates. Under the gold standard, countries running deficits had to raise interest rates to borrow enough to stabilize their currencies’ exchange rates. But for the U.S. economy, the larger the payments deficit, the more foreign capital was recycled into U.S. financial markets. Banks were able to create their own credit electronically without international constraint.

For the past thousand years the major factor in balance-of-payments deficits has been military. This often has led to a loss of economic sovereignty. But under the Treasury-bill standard the U.S. economy achieved a free lunch. Under the new monetary imperialism, foreign central banks absorbed the cost of U.S. military spending—and in due course the U.S. private- sector takeover of their economies.

Monetarily, the U.S. payments deficit had become inflationary, not deflationary as was the rule for all countries in times past. However, the inflation was contained entirely within the U.S. financial and real estate markets. Labor and consumers were not the beneficiaries.

Stay tuned for Part IV in the series.