Archive for September, 2011

The supply side argument goes that if companies (and the rich) have more money (through incentives, lower tax rates, etc.), they will use that extra money to invest and create jobs.

This argument is silly.  Republicans have been making this argument since Reagan, and perhaps they really believe it…but it just doesn’t make sense. (And to boot, the empirical evidence says it is wrong as well.  In an environment of overcapacity, supply side policies just make the rich richer.)

Why?

Imagine a gold rush.  People come and dig up gold.  Merchants spring up around the mines and rivers to sell to the people.  The merchants get rich.  Then the gold starts to dry up.  The local government gives tax breaks to the merchants to stay in the town and continue to sell, to employ some of the people that were previously miners.

Do the merchants take the extra money and invest in the town, employ some extra people…or do they take the money from the tax breaks (and all the rest of the money they’ve saved over the previous boom) and move to another boom town?

Easy:  They take their money and leave.

Why?

No one in the city has any money to buy their products.

How does this apply to us?

1) Tax breaks for companies and the rich do not create jobs if there is no one to sell to.

If the companies and the rich take an ever larger share of GDP growth (which they are), people will not have any money to buy their goods…and that will eventually be bad for all parties.

It may make sense for any one company, or any one rich person to try to amass as much as possible; however, the model falls apart if it happens in aggregate.  History is pretty clear on what happens when the rich get too much and the rest have too little.

Henry Ford famously paid people twice the going wage so that people could afford to buy his cars.  Conversely, if we all work at McDonalds (or are unemployed), have houses with negative equity (and mountains of student debt), and are one health issue away from bankruptcy….no amount of tax breaks in the world will incent companies to try to sell to us.  We won’t be able to buy anything.

The rich do not create a lot of demand for real goods; if you give them more money they simply have more money.  A tax/incentive structure that favors wealth distribution to the middle and lower classes creates demand.

To illustrate, if a rich man has enough money to buy 4 houses, he will not buy 4 houses.  He might buy 2.  If you divide the money among 4 middle class people, they will buy 4 houses.

2) Companies are not in business to hire people.  It isn’t their purpose.  They are in business to make money.  They would hire ZERO people if they could get away with it.

If, before the recession, emerging markets were the best place for companies to invest, then after the recession if you give them more money, they will invest even faster in emerging markets.  It does not make them want to hire more people in the US, especially when those people don’t have any money.

Let me repeat it again more plainly: If a business’s purpose is to make money, and you give them money (through tax breaks), then why hire people?  They’ve already achieved their purpose.  Businesses hire based on demand, not profit.

Also, all this mess about companies are not hiring “because they can’t get credit” or “because they are ‘uncertain’ about future regulations” is complete crap.

Let’s take these one at a time:

1) Companies are not hiring because they can’t get credit.

Credit is the easiest thing in the world to get; it is created out of thin air.  If there is no credit available, the most likely reason is that the people (or businesses) asking for credit are not credit-worthy.  Banks are  not lending as much as before the crisis; there is a ton of bad debt out there and no one knows what is going to happen with it.  That creates uncertainty…no doubt; however, please be reminded that the Banks themselves created the uncertainty that is now causing them to be uncertain about lending.

2) Companies are “uncertain” about future regulations.

This is complete crap.  I don’t doubt that there is some uncertainty about future regulations that might affect business.  No argument.  However, I know for a fact that companies do not sit around wondering about regulations that might have some affect on them in some number of years.  Companies are not nearly so forward-looking.  I work in HR consulting and we haven’t had not one company come to us asking what to do about the new healthcare regulation.  And I work in HR!!  If HR isn’t asking, the business itself is certainly not asking.

Business decisions to hire or not are much more immediate; they are not forward looking.  Companies do not hire until the very last second when the demand needed to keep that person busy has already existed for months and current employees are starting to complain or leave because of the workload.  If they cannot leave (and with high unemployment they often can’t), they don’t need to hire anyone else at all.

Again, it is about demand for the business’s goods/services, only then might a company hire.  They might also just buy additional equipment to automate, or hire someone in another country.  To repeat:  Giving a company more money does not incent them to hire people.

So do I have a policy recommendation?

Sure, when there is overcapacity (excess labor, or plant capacity) it is DEMAND that matters.  More supply won’t make a lick of difference as there is already over-supply (we have excess plant capacity and plenty of labor on the sidelines already).

So we must create demand. How do we do that?

1) The government can temporarily produce demand by deficit spending. However, it must be deficit spending.  It cannot be funded stimulus.  If it were funded then the government is taxing money away from us to re-spend the money on us.  The net result is zero.  If they hadn’t taxed the money in the first place, we would’ve spent it anyway.  That isn’t stimulus (unless we think the government can spend it better than us, which might be the case if all the money is going to the rich).

Unfunded (deficit) spending is new demand that would not have existed otherwise.  The jobs program is a fine idea for a policy recommendation.

I’ll tell you what isn’t a good idea:  Austerity.  The balanced budget camp needs a wake up call.  You can make all the arguments you want about the long term needs for a small government with continually balanced budgets; that is a big and worthy question….however, the short term effect of less spending is less demand….which is bad.  Let me repeat:  Austerity is bad for us in the short term.

2) Hmm…..the longer term issue of how to create demand is more complicated.

How do you level out income inequality so that people actually have money to spend?

How do you compete with economies like India and China that have absolute, not comparative, advantage?

How do you keep the financial sector from ruining the economy again?

How do we keep down run-away healthcare costs?

How do we improve education while keeping its costs (which are rising faster than healthcare’s) down?

Is the day finally arriving where technology is eliminating jobs faster than we are creating them?

Can we maintain our standard of living in a service-based economy?

Can we sustain our out-sized military spending?

What level of societal welfare benefits do we consider appropriate?

When does it become a supply and not a demand issue? Stated another way:  How much GDP growth (demand) would eventually wreck the environment (supply)?

So, that’s it.  Simple.  In the short term, with excess capacity, we must create demand.

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We will all look back in 100 years and wonder why people ever invested in the stock market.  It will seem like such an obviously misguided and colossally bad idea; how did we ever think that could work out?

I admit that I do not understand the stock market.  It isn’t that I don’t understand how to pick stocks (I don’t but that is beside the point); it is that I don’t understand the CONCEPT of the stock market: Why pay money for stocks?  Why use a second hand swap meet of useless company baseball cards as a vehicle to save for retirement?  It is silly.

Point 1:  As in poker, you need to know which table to play at.  Put another way, inside information is the only way to consistently beat the market.

Regular folks investing in stocks is like you trying to win at the World Series of Poker.  We are like a toy boat on the ocean;  it would just be luck if we ended up where we wanted.

Along this same line, I disagree with making it illegal to trade on inside information.

Publicly the industry needs to say it is illegal to trade on inside information.  Why?  Because no idiot (meaning us) would invest in the stock market if they knew the game was rigged to benefit those with special information.  That is the democratic draw of the stock market; average people can participate and win…after all, the information is all out there, right?  WRONG.

Funds or people that beat the market consistently and trade frequently are likely cheating with inside information…period.  Mathematically it wouldn’t be hard to target any group/fund/person with consistent market beating returns that are outside a normal range….and assume they are cheating.  Start investigating them.

The reason I am for making insider trading legal instead of investigating everyone is that if you made it legal, people would hopefully stop thinking of the stock market as a vehicle for savings and start thinking about it for what it is:  A cutthroat gambling casino for the ultra-rich where the buy in is OUR money.

I don’t have a problem with the ultra-rich betting against themselves all day with their own money; if they wreck that stock market it only wrecks them.  The problem is that we give them OUR money and then they wreck that stock market and get bailed out.  In that scenario, they win if they win, and they win if we lose.  Seems like a pretty good deal for the finance folks, huh?

Point 2: How can stocks go up faster than inflation + growth?

No asset class can consistently outpace inflation + real growth over time.  People say Social Security doesn’t appreciate like stocks do; your rate of return would be better with stocks.  WRONG.  It might be better over time...but just wait until the first generation of people try to retire who have seen negative stock returns over their period of savings.  That will be the end of stocks as a retirement savings vehicle, and those people will eat potatoes and live by the wood fireplace in the winter.

It will also make us, as a nation, forever chained to the fortunes of the stock market (a very bad idea).  The government will always have to intervene if the stock market tanks because so much is tied up in it. This is a moral hazard for traders, since they know they will always be bailed out.  Additionally, their speculation is at the expense of our retirement.

This scenario of negative stock returns for retirees over the period of their career simply hasn’t happened yet. 100 years ago there was no retirement.  It is a modern concept.  Then there were pension plans (and Social Security), which were ponzi-like schemes where you always needed a larger portion of workers paying in than old people taking out to maintain them.  401K plans didn’t exist until the 1978, so basically no generation has yet retired depending on stocks.  Using stocks as a vehicle for normal people to save is a new and unproven concept.

If stocks cannot consistently outpace inflation + growth, then putting your money in the stock market is little more than gambling…and gambling against people who know a lot more about it than you.

Point 3: The miracle of compound interest only works if everyone doesn’t employ it. If stocks worked their magic for us and multiplied our money through investing, and then everyone was able to do that, would we all be rich? NO. Compounding interest can create money on paper no doubt; but it will only ever be able to buy what is available in the real world.  It would simply create inflation. I repeat:  No asset class can consistently compound faster than inflation + growth for everyone.

Point 4: Stocks don’t produce anything.  We can’t all be rent seekers.

If we were all, every single one of us, able to use stocks as a retirement vehicle to compound our money while doing nothing, then what would we be able to buy?  Other people’s stocks perhaps, but there would be nothing else to spend our money on.  In short, wealth is produced by improving stuff, by working…not by shuffling paper in a second hand market.  You can’t eat a stock certificate.

Point 5:  Traders and computers (HFT) will ruin the stock market.

The primary players (traders and computers) are not looking to invest; they are looking for arbitrage.  They don’t care about investments, or the health of the underlying economy; they are simply looking for the next trade, whether it is in pork bellies or Swiss Francs.  The larger the market gets, the more tempting it is to try to rent seek from it.  They are extracting profits from doing nothing.

~70% of trades are computers trading against other computers.  Why would we agree to participate in this?  The stock market has devolved into a computer game, and we are the losers.

As we look back in 100 years (probably less), we will realize that it was a rigged game, whose main benefit was to extract money from the dupes (us) and funnel it to the rule makers (traders).  We supplied the fuel; they extracted the profits.  In the end very little was ever financed; very little was returned, and all the financiers got rich.

I took a religion class in college and always thought it was odd that nearly all major religions single out usury/banking as evil.  Why single out one profession above others?  What is so insidious about banking that it gets a special mention above other professions?  Well, it is because they have a tendency to end up with all the money, when they don’t really do anything; it is simply fancy theft.

The stock market is the crowning achievement of fancy theft.  We will look back in 100 years and wonder how we could’ve ever thought buying stocks was a good idea…just like no one could’ve thought smoking was good idea, right?

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