26 January 2012

Phony Financial Profits

I thought the most important line in the president's State of the Union speech tuesday was this:   "We will not go back to an economy weakened by outsourcing, bad debt, and phony financial profits," especially that last phrase.   I've heard a little about the strengthening of enforcement he's suggesting, but not much about the "phony financial profits" line, except from WaPo's astonishingly clueless fact checker, Glenn Kessler: "That's a bit of a mystery to me."  

When he created the US stock market and investment system, Alexander Hamilton talked about the value it would create by providing financial support to new businesses.  That's it's sole purpose.  Except for promoting the creation and expansion of other businesses, businesses with real products, finance is nothing but a parasite.  If we truly had an efficient market, finance would do only what's necessary to promote other investment, and any parasitism would be driven out.  But that's not what we have.  We have IPOs with the sole function of allowing investors to maximize profits before the company crashes and dies.  We have robotrading, whose function is to extract a fraction of a cent from trillions of trades, getting in a fraction of a second before the other guy.  We have wild speculation in various commodities markets, way out of line with supply and demand.  And most importantly, we have bubbles, from the tulip craze and various precious metals crazes, to the dot com and housing bubbles.

Every one of these bad things things is driven, entirely, by phony financial profits.  They're real money, but they have phony value--that is to say, the real value in goods and services being traded is much smaller than the amount of money involved.  Phony financial profits drive inflation, they crowd out real investment, they separate money from the people who provided the value, they provide an incentive for fraud, they cause financial panics.
They are a bad thing.  We need financial profits, but only enough to promote business ventures, and no more.  When they become excessive, or "phony" in the president's succinct characterization, the economy blows up.

The key is regulating excesses.  Banking serves an important function all through the economy, so we must keep it strong and safe.   No speculation, very limited levels of leverage.  Finance serves an important function too, but it's inherently speculative.  It can't be allowed to pollute banking, and institutions must be kept small enough that when they fail, as some inevitably will, the consequences to the overall economy will be negligible.  This is the heart of the free market.  (The head of the free market are the entrepreneurs who create the businesses and the body is the workers...)  And purely parasitic behaviors, such as robotrading and fraud, should be stopped.

02 January 2012

The Deficit

The republicans are all up in arms about the deficit and the debt.  Too bad they weren't this worked up about it while the debt was being racked up...we'd be in a very different position than we are.

Here's an interesting group of tables that I like a lot.  He puts together a number of correlations--by party, president, who controls congress, top tax rate and so forth.  There are a number of important correlations to be seen and a number of surprising statistics.

Studying Table 1 carefully shows clearly that increases in the deficit correlate to three things: Tax cuts, wars and economic downturns.   With one surprising exception, reduction in the deficit correlates to one thing only: tax hikes.  The effect of the Reagan, GHW Bush, and Clinton tax hikes can clearly be seen in the data, and it overwhelms the effects of other factors.

Table 3 shows that 6 of the 17 presidents in the past century have reduced the deficit: Wilson, Truman, Eisenhower, Carter, Clinton and Obama.   Wilson, Truman and Eisenhower all presided over the ending of a war and an economic boom.   Wilson raised taxes to pay for WWI.  Truman and Eisenhower's predecessors had done the same.  Carter presided over a period of high inflation, during which time the deficit increased in nominal terms, but decreased in constant (corrected by CPI) dollars--he left taxes at their previous, high rate.  Clinton raised taxes and presided over a sharply rising economy.

Obama's situation is a little more complicated.  He took office shortly after the start of the deepest recession since the Great Depression of 1929-39, and the economy continued to plummet for months after he took office.  The ARRA put the brakes on the plummet, but added about $400B to the deficit in both FY 2009 and 2010.  Because FY 2009 started under GW Bush, those $400B are added to his totals. Even if we move this $400B from GWB to Obama, GWB raised the deficit by over $600B 1983 dollars and Obama has reduced it by $150B 1983 dollars.

As they always say, past performance is not necessarily a predictor of future performance, but if Obama's average improvement in the deficit were to continue, the deficit will become a surplus in February 2015.  This is unlikely.  CBO projects the deficit stabilizing at about $500B after 2013, and this is probably correct--the republicans certainly won't allow anything to improve the economy or budget while Obama is in office, and they've never before done anything to improve the economy or budget while they've had power themselves.   But note that this is lower than the non-recession Bush deficits of 2003-2007, although not much. 

The other 11 presidents since Wilson took office in 1913 all increased the deficit.