Three weeks ago, I tweeted that we were now in the same position as we had been in prior to the Great Depression.

The stock market that day was at 3,090 on the S&P. Today is March 23, 2020, and we’re at 2,237, the fastest three-week drop in 100 years. Proclamations of a new Great Depression, little heard 3 weeks ago, are now commonplace.

While I didn’t know that day that what I was saying would sound much less fantastic in just a few weeks, I did know that the economy was in trouble, in a general sense. And I knew the next recession that came along was not going to be pretty.

So why am I writing this? Because what I saw and how I saw it tells us a lot about why we are where we are (it’s not, in a deep sense, due simply to CoVid-19), what we can expect, and what will (and won’t) help to get us out of this mess.

Let’s start with the first Great Depression. In the 1930’s, unemployment skyrocketed to a peak of 25%, and stayed high for most of a decade. Economic misery everywhere led eventually to the rise of populism, Nazism, WWII, and the Holocaust.

John Maynard Keynes looked around during the Great Depression at empty, idle factories everywhere, and realized we had plenty of productive capacity to provide for everyone, yet the entire country was suffering greatly from unemployment, and terrible business conditions.

Keynes realized that while no reduction had been made to our potential aggregate supply, the entire country was suffering from involuntary idleness, of both worker and factory. A paradoxical idleness combined with scarcity.

Businesses couldn’t afford to hire workers, and workers couldn’t afford to buy from businesses. Clearly, the problem was one of aggregate demand. Keynes’s “paradox of thrift” begins to explain how this happens. In depressionary conditions, business layoffs lead to reduced consumer spending, which hurts businesses and leads to even more layoffs. A vicious spiral.

But Keynes was unable to successfully explain why it was in that particular time, and not others, that the conditions for a crash in aggregate demand arose. Keynes’s only attempted explanations were 1) speculation, and 2) “animal spirits.”

But both of these are also present at any other time, leaving us still with the question, why in that time (the 1930’s) and not others?

Above is a graph showing wealth inequality from 1910 to present. It shows a clear peak in wealth inequality around 1930, declining until about 1980, then increasing again to a new peak in present times.

But what does wealth inequality have to do with a Great Depression? The relevance becomes clear if you divide society into two parts, workers and capitalists.

Capitalists earn their income by saving and investing in capital, which generates a continuous productivity benefit over time. Such as investing in a factory, which then produces a certain amount of goods, and generates a certain amount of income every year, after the initial investment.

Workers, in contrast, earn their income by selling their labor. One important difference between the two is that workers have a much higher marginal propensity to consume (MPC). Workers tend to spend most or all of their income.

Capitalists, on the other hand, tend to exist in a state of individual post-scarcity, saving much of their income to invest in still more capital, and having more than enough income to completely satisfy any reasonable material desire.

The different marginal propensities to consume (MPC) is important to our story.

If you imagine the development of this “capitalists and workers” society over time, you’ll quickly discover what Thomas Piketty calls r > g. By saving and investing much of their income, capitalists continually increase their capital, and also their income. Wealth tends to concentrate upwards.

For a more detailed perspective, let’s examine the phenomenon of productivity growth, which most economists would agree is the fundamental underpinning of growth in the economy.

Productivity growth occurs when a business invests in a new factory, new machinery, or even new software, that allows a greater amount of products or services to be produced using a lesser amount of labor.

The popular but unexamined assumption is that productivity growth benefits workers by allowing wages to increase. While this seems reasonable at first glance, a closer analysis shows that, while productivity growth is beneficial to society as a whole and to the capitalist, it necessarily leads to a deterioration of the position of the worker, relative to the rest of society.

Consider the example of Walmart automating away cashiers. In this example, there’s a small group of engineers who earn a high income automating millions of jobs. However, even including them as workers, this necessarily is a net transfer of income from workers to capitalist.

The workers’ income here is the capitalist’s expense. If investing in this form of productivity growth did not provide a net reduction in Walmart’s expenses and in the workers’ income, Walmart wouldn’t do it.

Of course, the capitalist (Walmart, or the Walmart shareholder) may now spend part of their now-increased income on workers again, but only at a net profit to themselves. The net effect is necessarily a relative gain to the capitalist’s share of society’s income and a relative loss to the worker’s share, even as the total productivity and income of society increases.

All increases in productivity growth follow this same basic formula and result in a small relative transfer of income share from worker to capitalist.

Is this a problem?

Remember, the capitalist has a much lower marginal propensity-to-consume than the worker. The income of the capitalist goes primarily to investments, increasing the capital of society; while the income of the worker goes primarily to consumption, increasing the consumption of society.

As a result, society will move towards an imbalance of too much excess capital (generating an excess of aggregate supply), and too little consumption (a lack of aggregate demand).

The increase in wealth inequality leads to slack aggregate demand, because all of the money is stuck in the hands of the capitalist, who won’t spend it on consumption, and less and less money remains in the hands of the workers, who would spend on consumption, but cannot because they have no money.

Alan Watts once drew an analogy where a business owner invests in a wonderful automated factory, lays off his workers, and turns around to find no one can afford to buy the products, because they’ve been laid off.

As purchasing power concentrates in the hands of the wealthy and out of the hands of normal workers/consumers who make up the bulk of society, this is exactly the situation we find ourselves in.

This trend begins slowly, but eventually accelerates into Keynes’s paradox of thrift. Slack aggregate demand due to the worker’s declining share of relative income combines with the increase in productivity (which allows more production with less labor) to press down on demand for labor and price of labor (real wages), which further reduces worker’s relative income, eventually generating a vicious cycle and a self-reinforcing crash in aggregate demand, given enough time.

In Keynes’s formulation, layoffs lead to a reduction in consumer spending, which hurts businesses, and results in still more layoffs.

But the entrance to the vicious cycle and the paradox of thrift occurs when, over a long period of time, productivity growth progressively eats away at the position of the worker relative to the capitalist, and wealth inequality accumulates, to the point of generating the self-reinforcing crash in aggregate demand.

The final result is a Great Depression.

Do we see evidence of these theoretical dynamics in the economy in the past 50 years? We do.

Real wages for non-management workers stagnated in the 70’s and haven’t grown since.

Slack aggregate demand shows up in a low capacity utilization in the economy: 77% even prior to the beginning of the 2020 crisis.

It’s notable that capacity utilization prior to the Great Depression was similar, at 79%, falling to 67% as the crisis unfolded.

The imbalance of too-low consumption with too-high capital also makes it unprofitable to continue to make real investments for further productivity growth. On the one hand, wages are too low to incentivize productivity increases; and on the other hand, consumers no longer have money to increase spending and buy up any increases in production. As a result, we also see a drop-off in real investment and productivity growth as we reach the limit of the consumption-capital imbalance.

Finally, the lack of profitable opportunities for real investment due to slack aggregate demand results in an excess of idle capital. Without real investment opportunities, the idle capital drives down returns and generates financial bubbles in every corner, including stock bubbles, real estate bubbles, and bond bubbles. Bubbles have been the rule rather than the exception ever since Alan Greenspan diagnosed “irrational exuberance” in 1996.

An even more extreme stock bubble can be seen in the prior analogous period, peaking in 1929.

For comparison, a period with lower wealth inequality does not show as extreme market bubbles.

The Capital-Consumption Cycle view of society comprising two parts, capitalists and workers, with capitalists providing the bulk of capital accumulation, and workers providing the bulk of consumption, explains:

Slack labor demand and stagnant real wages for the past 45 years. Slack aggregate demand in the current era, requiring and persisting despite extreme monetary policy (zero and near-zero interest rates), and extreme fiscal policy (trillion-dollar deficits and rising). Falling real investment and falling productivity growth. Excess idle capital generating financial bubbles in every corner ever since Greenspan’s 1996 “irrational exuberance.”

The important thing to understand about the current crisis is that, while the trigger has been a medical crisis in the form of CoVid-19, the conditions for slack aggregate demand to enter the vicious cycle of Keynes’s paradox of thrift have been building for 45 years. The current record spate of layoffs and unemployment will cause a drastic reduction in consumer spending, which will further hurt businesses, leading to more layoffs and unemployment.

Even after the medical crisis passes, the only way to prevent or end the new Great Depression will be to reflate the consumer through a supplementary Universal Basic Income.

In the absence of adequate injection of spending power directly in the hands of the consumer, the extreme imbalance of capital’s enormous productive capacity with the consumer’s fading ability to consume inevitably lead to unemployment of both capital *and* workers, leading to a self-reinforcing crash in aggregate demand and a Great Depression.

As in the 1930’s, the question is now not if, but when, the economic misery will prove to be sufficient to make the alternative to progressive economic reform entirely unacceptable.

How much more pain must we experience before we learn?