Karl Marx must be smiling in his grave. In communism, the means of production are owned by the state or community. There is no private ownership of property. Individuals are not incentivised to accumulate wealth. Capitalism allows all this, and more. There is competition for labour, land and capital. However, over time, the winner-take-all attitude builds up excesses that ordinarily get corrected during recessions. Yet, rising central-bank activism is not letting business cycles play out. From ownership of sovereign and corporate debt to even stocks in corporations, major central banks’ tentacles are spreading wider. Should this continue, governments will end up owning more and more of the private sector. Ironically, it was state control that sunk communism in many countries.

State control proves costly for communism

In 1848, Marx and Friedrich Engels published The Communist Manifesto. In 1917, the October Revolution overthrew the Russian czar; a civil war followed, ending in the Vladimir Lenin-led Bolsheviks’ victory in 1922. The Soviet Union was born. For much of the 20th century, it went toe-to-toe with the US militarily and economically. But deep down, the command economy was unable to compete on the global stage, finally unravelling in 1991 when Mikhail Gorbachev, father of perestroika and glasnost, resigned. In China, communism began with Mao Zedong’s rise to power in 1949. But to survive, China underwent market-economy reforms under Deng Xiaoping, who gradually rose to power after Mao passed away in 1976.

After the Cold War ended, large-scale privatisation of state-owned assets took place in Russia—most of it under Boris Yeltsin in the early and mid-1990s. The transition was chaotic, with a transfer of significant wealth to a small group of oligarchs and New Russians. Over time, economic inequality grew. In fact, even in market economies such as the United Kingdom, the 1980s saw a major drive to privatise state-owned businesses. Under Margaret Thatcher, who was in power from 1979 to 1990, more than 40 state-owned businesses were privatised. In the US—the bastion of capitalism—under Ronald Reagan’s supply-side economics between 1981 and 1989, the public sector was routinely defunded. Importantly, debt was no longer a taboo.

When Reagan entered the White House, inflation and interest rates were peaking. Consumer inflation was over 14 percent in 1980 and the benchmark rate was at 19 percent in 1981. As they fell, growth followed. Real GDP growth averaged 3.5 percent during his tenure. But federal debt nearly tripled to just under $2.7 trillion, while federal budget deficit averaged 4.3 percent of nominal GDP. Both individual and corporate tax rates were cut; government spending did not go down as expected. Importantly, continuing a trend that began in the 1970s, the gap between rich and poor widened. Further, deficit financing was no longer loathed. In the 1987 movie Wall Street, Michael Douglas as Gordon Gekko declares, ‘Greed, for lack of a better word, is good’.

This cultural shift in the 1980s preceded the final nail in the coffin of the gold standard in 1971. In it, countries fix the value of their currencies on a fixed amount of gold. After Germany adopted the standard in 1871 until World War I began in 1914, international trade was settled using gold. Yet, when times were tough, it was felt that the system was too rigid. In 1931, Britain stopped using it. The US, ravaged by the Great Depression, followed suit in 1933 when Franklin D Roosevelt criminalised the possession of gold. In 1971, Richard Nixon ended the dollar’s direct convertibility into gold for foreign governments. Welcome to the era of fiat money, which is not backed by anything.

Central banks wield unfettered powers

Under fiat money, central banks have more flexibility. But as time went by, they began paying more attention to stock markets and the wealth effect. Paul Volcker who, under Jimmy Carter and Reagan, broke the back of US inflation, was long gone. His successor at the Federal Reserve, Alan Greenspan, fearing deflation, sharply lowered rates in the early 2000s, sowing the seeds of housing and equity bubbles, leading to the financial crisis of 2007-08. The global financial system was on the brink of collapse. In response, the Fed rightly lowered rates to near zero and aggressively expanded its balance sheet. Other central banks followed, including the Bank of Japan, which adopted quantitative easing (QE) as far back as the early 2000s.

Investors responded to this firehose of liquidity by moving up the risk curve and pushing up stocks. The global economy began to grow. Concurrently, US markets realised that they had the Fed by the tail. Anytime it tried to raise rates on a sustained basis and/or reduce its bloated balance sheet, markets threw a tantrum. This was true under both Ben Bernanke and Janet Yellen, and it is true now under Jerome Powell. In fact, since there are no more arrows left in the conventional monetary quiver, central banks are having to invent newer unconventional tools. In the wake of the 2007-08 crisis, benchmark rates went negative in Europe and Japan. Subsequently, both the European Central Bank and the Bank of Japan began buying corporate bonds.

In fact, the BoJ since 2013 has even been buying equity exchange-traded funds. It feels like it is only a matter of time before the increasingly interventionist US Fed goes there. In March, in response to the Covid-19 crisis, it began buying corporate bonds, including junk. Its balance sheet has grown to $7.1 trillion, up nearly $3 trillion this year. Simply put, the Fed is cornered and has itself to blame. When economic cycles are not allowed to go through their natural peaks and troughs, failing companies drag on, leading to capital misallocation. Creative destruction is denied. From the time the Fed intervened in the 2007-08 crisis to the present, US debt load is higher, with federal debt nearing $26 trillion. It takes more debt to produce the same output.

A leveraged economy means the Fed cannot afford higher rates. Each time there is a crisis, markets, hooked on Fed largesse, expect more. In the end, the Fed will end up owning more and more assets. There is a precedent. As of the third quarter of 2019, the Bank of Japan owned some 8 percent of the entire Japanese equity market. As of the same date, the Swiss National Bank owned US stocks worth $94 billion. It is anyone’s guess as to how things will shake out in the US in the next five to 10 years or longer. Rationally, unless serious reform takes place within capitalism to bridge the rich-poor divide and the Fed returns to normal business, it will be increasingly difficult differentiating between capitalism and communism.

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