Brad DeLong's Semi-Daily Journal (2004)

Wot! Nuke "The Sage of Omaha"? the dastards.

Does this explain the old 'missing productivity' mystery, or Solow's paradox? It just took time for industries to incorporate IT progress and figure out how to cut back workers? At some point in the '90s industries had figured out enough to start that wheeling motion of structural change, and the productivity growth that had been hidden began to appear in the statistics. Since IT continues to advance and spread, the pressure to hire is reduced.

Or have I been in a hole for the past couple years and everyone already knows this?

I don't want to underestimate their job, but at times, the Fed is giving us the same kind of ride you get in a cheap airport shuttle. Or is it that some were a little over-zealous in pricking the dotcom bubble? Retrospectively, it does feel like the Fed has been a bit inconsistent in this matter. Reminds me of the Elvis diet: too many sleeping pills in the evening and emphetamines in the morning, repeat... Of course, I credit them with avoiding the most dangerous rocks of deflation and deeper recession, but what if they have to prick another buble in 2005-6? What I am most uneasy about is how the Fed gave this Administration and Congress a blank check on fiscal policy. AG even went out of his way to help Bush his no-employment and no-growth tax cut package. Lately, it's even become hard not to think that AG has wished to bring down Social Security all the way. That's bound to haunt the Fed and its future independence. I have respect for the institution but not to the point of refraining from ever critizing them; such a requirement would be... well... undemocratic?

Yeah, if only there had been no tax cuts for the evil rich, none of the dozens of economic problems you have listed over the past weeks would have happened. Everyone would have jobs, nobody would be outsourcing, and Osama would have forsworn terrorism and called his followers to become rose gardeners.

The obsession with the tax cuts is getting bizarre. I assume the alternative you would recommend is taxing the crap out of the $200,000+ crowd and give more tax breaks to the bottom 50 percent. You know, if you completely eliminated the income tax for the bottom 50 percent, it would add a grand total of about 35 billion dollars to the economy.

Or maybe the policies would be massive government employment, like Roosevelt. We can hire all those IT guys to pick up litter in national parks for 30 bucks an hour. Deficits? What deficits?

What's your "better idea?" Or Kerry's for that matter? Simply saying "policies that would stimulate the economy" is a little vague.

"Policies that would actually stimulate the economy"? We didn't see a staggering growth rate of 8.2% in the quarter IMMEDIATLEY following Bush's "tax cut for the rich" in late May?

"giant wheeling motion of structural change" already wheeled American consumer electronics industry and a large portion of semiconductor manufacturing to Asia. You could make an argument that nuclear, airspace or semiconductor engineers became programmers. How anybody can look people straight in the eye and say that programmers became "education and health workers" is absolutely beyond me. Brad, that includes you.

A simple math: it takes 4 years to train a nurse. American IT employment stopped in 2001. Which "health worker" positions were taken by the engineers laid off in 2001, 2002 and 2003?

tbrosz writes: "Or maybe the policies would be massive government employment, like Roosevelt. We can hire all those IT guys to pick up litter in national parks for 30 bucks an hour. Deficits? What deficits"

That seems to be Bush's plan... February's net job increase of 21,000 is entirely accounted for by government jobs.

OT: A story in the local paper about the CT job situation said that tribal casino jobs count as 'government' jobs. Is this true?

tbrosz, as I've more or less stated before, OK, maybe I haven't...let me start from the beginning.
You seem to think that any government at all is an encroachment upon property rights, when property rights wouldn't exist at all, w/o government. If you doubt the validity of that statement, there are many places you are totally free to move to, that have minimal/no/totally broken governments. Please feel more than free to go move to one, and report your results.

'America, love it, or leave it'...those are shootin' words, to me. I was born here, dammit. YOU frigging leave it....
BTW, I qualified expert with an M-16...

Krugman agrees. No more excuses on jobs:

www.nytimes.com/2004/03/12/opinion/12KRUG.html

You know, I didn't really see what Brad was getting at. Now I do.

He's a demand-sider. Which is not a bad place to be.

tsboz:You miss the point. If the tax cuts were focused on the middle/lower classes, demand for goods and services would have went up, creating more need to employ people, creating more need for goods and services, and so on.

That's the fundimental argument here. Do companies hire by way of investment, or does demand/work need to be done force companies to increase their workforce?

Myself, I say the latter. Although, I'm not as rosey on offshoring, mainly because it's another nail in that particular coffin, (being stagnating wages which=stagnating demand.

"You know, if you completely eliminated the income tax for the bottom 50 percent, it would add a grand total of about 35 billion dollars to the economy."

tbrosz,

Why limit yourself to the bottom 50%? Over 40% of Bush's tax cuts went to the top 1%, which starts at around $275,000. Add the 2-3 more points to encompass the rest of the $200k plus group and you could've suggested reducing taxes, to stimulate demand, for 96% of the country, not just 50%. That's more than $35 B of stimulus. Also, like your brethren in the Administration you're stuck on income taxes. How about reducing payroll taxes?

As for conflating Al Qaeda with an economy perpetually ready to stall, well perhaps come to think of it you're right. It *is* our country's leaders who are muddling these issues that is causing diminished confidence in our economy.

Chris-- your comments gets to the heart of the debate-- the 8% growth last year developed just after the Bush program did provide a tax cut for the middle class. A small part of the tax cuts did actually work as a stimulous and we saw it last year. But that was the only part that worked. All the rest did was give the wealthy tax cuts so they could use the lower taxs to loan the govt the money to finance the deficit -- a closed loop with little stimulous.

tbrosz, Kerry wants to roll back the tax cuts for the top 2%. That's it. So when we have these debates, let's be clear what we're arguing about: you think 98% of Americans should pay higher taxes (since the deficits are going to have to be paid for eventually) so that the top 2% can have their taxes cut. I would be pleasantly surprised if Bush actually campaigns on that platform.

"...and Osama would have forsworn terrorism and called his followers to become rose gardeners."

I know. How silly to think that just taxation would fight terrorism. Everyone knows that bombing the shit out of Baghdad was supposed to do _that_! You know, tbrosz, not everything ties in to the War on Terra--and it's not as though Bush can be proud even of that. But I sympathize with your discomfiture.

Can someone help with a question - why do tax cuts for the $300k+ crowd ("rich") work differently than tax cuts for the <$300k+ crowd ("poor")? The rich will save their tax cut which reduces the cost of money which, in turn, increases the disposable income of the borrowing poor, leading to increased consumption. If the poor received the tax cut they would presumably spend it in the same way. Where is the difference between increasing the poor's income with a direct tax cut or through reducing their costs? Thanks for the help.

I think Brad is being overly hasty in dismissing the significance of healthcare costs as a drag on hiring. A few data points from my own experience...I work in software development, though on the design/management side rather than actual coding.

I've been interviewing for jobs with large, Fortune 500 companies. What I'm finding is that jobs that in the recent past were filled by full-time employees are now filled exclusively by consultants. I've heard managers state flat-out to me that as a matter of policy they now never hire employees.

Note that in the short term this is not a money-saver for them. My total compensation is well beyond what it would be as a salaried employee, even including the cost of benefits, and don't forget to tack on an additional 20% or so for the agency. This is a pervasive practice in corporate America these days. If the culprit isn't health care costs, then what is it?

Chris-- your comments gets to the heart of the debate-- the 8% growth last year developed just after the Bush program did provide a tax cut for the middle class. A small part of the tax cuts did actually work as a stimulous and we saw it last year. But that was the only part that worked. All the rest did was give the wealthy tax cuts so they could use the lower taxs to loan the govt the money to finance the deficit -- a closed loop with little stimulous.

That's incorrect; the tax cuts in May were the ones aimed more at the upper classes. The ones in June of 2001 were the first-half...the "poor and middle class" tax cuts, if memory serves, and after those we saw improvement (though minimal) in the GDP. The breakout didn't take place until the ones "for the wealthy" in May of last year.

If you wish to claim that they're just loaning the money back to the government, I'd have to ask for a source. Seems an over-simplification to me...the boom in the stock market would indicate that they're investing it in many places.

[b]Can someone help with a question - why do tax cuts for the $300k+ crowd ("rich") work differently than tax cuts for the <$300k+ crowd ("poor")? The rich will save their tax cut which reduces the cost of money which, in turn, increases the disposable income of the borrowing poor, leading to increased consumption. If the poor received the tax cut they would presumably spend it in the same way. Where is the difference between increasing the poor's income with a direct tax cut or through reducing their costs? Thanks for the help.[/b]

I don't think people follow this reasoning through properly. Yes, the rich will "save" their money. But where? In banks, or long-term investments. In both cases, the money keeps moving throughout the economy. Rich people aren't burying it in their back yard, here. Every dollar gets spent, in the end. There's no way to stop any one person in the country from "touching" your dollar at some point without stuffing it in your mattress.

[b]I think Brad is being overly hasty in dismissing the significance of healthcare costs as a drag on hiring.[/b]

I agree completely. Bush has managed to reduce the price of capital, but not the price of employees, to put it crudely. The result is people taking advantage of these stimulative tax policies, but without the hiring that tends to go with that.

If Bush could get some kind of healthcare reform through, I really think you'd see a big difference.

"I don't think people follow this reasoning through properly. Yes, the rich will "save" their money. But where? In banks, or long-term investments. In both cases, the money keeps moving throughout the economy. Rich people aren't burying it in their back yard, here."

It's true that the 13 million families (top 1%) getting the bulk of Bush's tax cut, or even more so the 3500 families (top 0.1%) who really made out like bandits spent a portion of their windfall on luxury goods and additional vacation homes and some of that purchasing spree will eventually trickle down to working people. Also, some of the money that was tax-shifted from our kids to the rich got invested, but where? Bush's almost manufacturing czar put his in a factory north of Beijing. Probably a smart investment.

This is not just theoretical stuff, there's plenty of empirical evidence. If the federal government wants to stimulate demand with fiscal deficits then putting the newly printed money into the hands of working people has always produced the best results. That's why 80s Republicans chose "supply-side" rather than demand-side as the title for Reaganomics.

Today, Republicans have applied every label possible to Bush's tax cuts. Doesn't matter. The results are always the same.

Seeing as how we're not old friends, dennisS, forgive me for not taking your word on that. Where's the empirical evidence you speak of?

And, last I'd checked, Bush's first tax cut (in June of 2001) was aimed at "working people," and the effects on both the market, and the GDP, were pretty minimal. Yet the second cut (the one for the wealthy, in May of last year) was immediatey followed by one of the strongest quarters in decades. Why? Seems like a pretty straightforward test of the two philosophies, with a very definitive victor.

I can only presume that the error here is in assuming that economic growth is about stimulating demand. It isn't. A simple thought experiment shows as much: which was more difficult? Getting people to want to buy a machine that allowed them to travel great distances in a short period of time, or inventing and building the automobile? Right, the supply was the hard part...the demand was always there.

Economic growth is obviously not about green paper, it's about innovation, and innovation thrives when you reduce the burn on those who innovate; that is, entrepreneurs, and businesses. I've never understood why so many intelligent people fail to see this.

If the "giant wheeling motion of structural change" means that programmers and other knowledge workers should start training to become hospital orderlies then the economists better start running their models with trade tariffs.

Could you point me to a summary of the theory behind this assertion that tax cuts to the rich aren't as effective in stimulating the economy? The near manufacturing czar's investment in Beijing presumably required equipment manufactured in the U.S. which led to wages for somebody (presumably "poor" - <$300k) plus some contract work for a "rich" lawyer. Then the PRC worker used the machinery to make shoes at cut rate prices which the "poor" U.S. consumer bought and reduced their shoe bill, thereby increasing their disposable income. The net result still appears to be no difference in the stimulative impact whether tax cuts are sent directly to the "poor" or sent to the "rich" and transmitted to the "poor" in the form of wages or reduced costs for consumer goods. Thnaks for the help to understand this.

The issue, when fairness is not a part of the consideration, (as in why arrange for lower tax rates for people who make their living renting out their wealth than people who trade away hours of their lives), is bang for the buck. That is, if the government is going to engage in deficit spending and tax cuts to stimulate demand which tax cuts will produce the best results. Tax refunds to the rich when spent in China *may* result in increased demand for American products or it may not. Money spent in this country by working people will at least go thru several hands before it's delivered overseas.

Chris, the car story was cute. It reminded me of the famous exchange between Henry Ford and Walter Reuther.

John, just to pick up on DennisS's point: "stimulus" is different than the normal functioning of the economy. The 75-80% of American households with income below $80K have, by definition, lots of unmet needs: fixing the car, buying baby's new shoes, going to the dentist. Incremental income to these households gets spent rapidly because they are barely (if at all) keeping up now (look at household debt stats, and particularly credit-card debt).

The upper 1% of households by income may convince themselves that they have needs, but none of them is particularly pressing - the car is working, baby has new shoes, the dentist can be afforded. Whatever they do with the money, there is a lag, and since part of what they do with the money is to save it, there's a further lag until the bank lends it out, and since there's limited demand for loans right now from credit-worthy types....

That's why stimulative policies are aimed bottom-up....

"Chris, the car story was cute. It reminded me of the famous exchange between Henry Ford and Walter Reuther."

Does that mean you'll be attempting to address or respond to its reasoning, then?

"That's why stimulative policies are aimed bottom-up...."

Sure, there's some lag in saving. But not much; and, having lived most of my life in a middle-class or poor household, I can say with plenty of certainty that the money is not always instantly spent, either. Regardless, the point is that the money keeps moving.

If the stimulation is so much slower with the upper brackets, we wouldn't have seen such a massive surge in the third quarter last year immediately following the tax cut in May. I harp on this point, I know, but I think it bears repeating.

It would have been helpful if manufacturing had been included in the table of employment figures.

There is no debate that labor-saving technological change causes a decline in the demand for labor.

But so does free trade with low-wage countries, especially really big ones like China and India.

The problem is not so much how to disentangle these two causes, as how to live with the consequences. For in both cases, the tendency is to lower the real wage level at which the economy will be at full-employment.

How are we supposed to live with that? Especially, when capital's share of the economic pie continues to grow bigger, in both relative and absolute terms?

Our country has been there before, at least in general terms: which is how we got the eight-hour day with time-and-a-half overtime, the New Deal, Medicare, etc. In other words, progressive democratic reforms.

It would have helped if manufacturing had been included in that table of employment figures.

There is no debate that labor-saving technological change causes a decline in the demand for labor.

But so does free trade with low-wage countries, especially really big countries.

The problem is not so much how to distentangle these two causes, as how to live with the consequences. For in both cases, the tendency is to lower the real wage level at which the economy will be at full-employment.

How are we supposed to live with that? Especially, when capital's share of the economic pie continues to grow bigger, in both relative and absolute terms?

Our country has been there before, at least in general terms: which is how we got the eight-hour day with time-and-a-half overtime, the New Deal, Medicare, etc. In other words, progressive democratic reform.

thanks to DennisS and howard for the comments - but it's not convincing that there is a lag in bank lending (and there is no obvious reluctance on the part of banks to lend to non-creditworthy types). Didn't Alan Greenspan note that consumer debt was not a significant problem given the reduction in rates? This lends credence to the view that a tax cut to the rich that is saved results in a reduction in lending rates that increases the poor guy's disposable income. Is there an economic theory that addresses this point that I could review? Thanks again.

Chris -- Your are giving the standard supply side argument. If it were valid it should have worked even more in the 1980s when the reduction in marginal tax rate were much larger than under Bush.

I do not see any great shortage of americans unable to make a lot of money if they come up with a great invention or improvement -- just look at the list of the billioners in the magazines -- more and more of them are first generation. The bigger problem may be the movement towards ever greater income inequality.

But is the problem more one of supply and demand?
We has poor economic performance and investment in the 1980s and since 2000 for many reasons.
But the fact is that the only time over the last 20 years when we had true prosperity and an
investment led boom was when we rejected the supply-side thesis in the 1990s. How do you get around that point? I am still waiting for someone to explain how having the government absorb 25% of the domestic saving supply on a structural basis will lead to greater investment. In the 1990s the federal surplus plus foreign capital inflows financed almost 50% of the capital spending boom. From 1960 to 1980 trend real per capita income growth was over 3%. From 1980 to 1992 it fell well below 2%, bounced back over
3% from 1992 to 2000. Since 2000 it has been
zero. Now show me comparable facts that show that the supply side thesis works. There is nothing worse than a beautiful theory being disproved by the facts.

TIB-- the evidence is overwhelming that what you said is absolutely correct.

"Chris -- Your are giving the standard supply side argument. If it were valid it should have worked even more in the 1980s when the reduction in marginal tax rate were much larger than under Bush."

It DID work in the 1980s. Reagan's term saw an average GDP annualized growth rate of 3.49%. Clinton? 3.57%. And that's *with* the abyssmal 81-82 numbers, during which time Reagan had just taken office. So why do you regard the 80s as a disaster, and the 90s as a utopia?

"I do not see any great shortage of americans unable to make a lot of money if they come up with a great invention or improvement"

I'm not saying that innovation is no longer profitable; just that people respond to incentives. Innovation is primarily about risk...it's good for the country as a whole when entrepreneurs go out and assume the risks that come with starting a new business, which is why it's beneficial to enact policies which encourage businesses and entrepreneurs to do so.

"But the fact is that the only time over the last 20 years when we had true prosperity and an
investment led boom was when we rejected the supply-side thesis in the 1990s. How do you get around that point?"

I get around the point by noting that the stock market more than doubled (a 220% increase, by my calculations) during Reagan's Presidency. And also, by asking you just why you believe we "rejected" supply-side economics in the 1990s. I don't recall us doing any such thing.

"Now show me comparable facts that show that the supply side thesis works. There is nothing worse than a beautiful theory being disproved by the facts."

You need look no further than Bush's last two tax cuts. The first was aimed at the lower and middle classes, and produced only a trickle of improvement in the GDP and stock market. Immediately following the next phase of his cut in May, as I've stated several times before, we were treated to the largest annualized growth rate in two decades. If stimulating demand among the lower classes is the answer, why was the first cut met with such poor results, and the second, with such definitively positive results?

I also believe you can make a compelling case against Keynesianism from a purely theoretical, thought-experiment point of view, but that's another matter.

Chris: love that about the lower classes. Who do you think you are - Bill Gates?

Uh, no. I'm middle-class, actually. I was only using the terminology I generally recall hearing used to refer to the non-affluent.

In the past decade we've had nice year on year productivity increases. Productivity increases grow the pie -- they're generally a good thing. I'm hoping much of it comes from the application of IT, globalization, etc.

I wonder about demographics though. Over past 10 years the number of workers between the ages of 32 and 47 must have peaked, following the boomer's age path. Now the oldest boomers are almost 60. For knowledge workers productivity probably peaks, for most people, between the ages of 36 and 50. As we boomers move out of that range, will productivity decline?

Chris: if you are like a majority of the posters in this forum, you are young or middle-aged professional. That means you have no large (>$1M) endowment or stock holding, have quite a bit of debt and the only significant property you have (if any) is the equity in your home. If that is correct, you are about 12 months of unemployment away from the serious trouble, sorry, "joining the lower classes".

http://www.house.gov/jec/growth/function/function.htm

What is *really* scarey about this hasn't even been discussed yet. There are now more Americans employed by government than by the entire manufacturing sector in America. But every single state in the union is bankrupt, with the exception of Vermont, the Fed government is technically bankrupt too. What does that mean?

Every single state is playing with competitive contracting state services. The Fed got on board that profit-engine long ago. What does that mean?

The state operating budget cash-flow deficit has grown so huge, states are rushing to embrace competitive contracting as a way to "outsource" or "privatize" their middle service ranks. What does that mean?

States will be able to RIF employees off their operating budget payrolls then roll outsourcing contractors onto their **capital** budgets. What does that mean?

State managers will be able to crow how they cut operating expenses, while off-budgeting the real transition hit to capital expenditures now being bled off to support service contractors doing the same work, at the same cost, plus government administrative overhead!!!

What a deal!!

The state operating budget books look good, the state managers look good, the only ones taking the hits are the laid off mid-level government workers, falling into a bottomless and jobless economy without a safety net, the minimum-wage contract workers, and the duped taxpayers, who wonder why their property and sales taxes and income taxes still keep inching ever upwards, in some states, robbing nearly HALF their income!!

http://www.libertyhaven.com/theoreticalorphilosophicalissues/history/growthofgover.html

No one has addressed this accounting gimmick yet, but it's hitting the pavement right now, soon to make WorldCom look like a Little League batting practice before the 2004 World Series.

http://www.cato.org/pubs/pas/pa111.html

Factor that into your hiring stat's, Brad.

Ifthen Else: from your libertyhaven reference:

Every week the federal government sends out billions of dollars to farmers for growing (and in some cases, not growing) crops; to veterans for health care or retirement; to the unemployed for not working; to those with low incomes to pay for food and shelter; to college students to pay for school; to the elderly for being retired; to the elderly and poor to pay for health care; to unwed mothers to pay for the care of their children; and on and on.

I hope you are not advocating stopping aid to unemployed, students, veterans and eledrly.

john, i realize that it's probably too late for this particular thread, but: a.) i have no idea what you mean by the banks not having any obvious resistance to lending to non-creditworthy types - of course they have such a resistance; b.) the fact that household debt hasn't been a big problem because of low interest rates doesn't change the far more powerful fact that credit card debt is increasing because a large percentage of the households can't survive on their income, which is why they would spend tax cuts rapidly; c.) of course there's a lag if rich folks stick the money in the bank until the bank lends it - that's by definition; d.) but who cares, because very few rich folks are going to stick the money in the bank, where they earn 1%, when they can buy bonds at 4% and up, thereby simultaneously having a lower tax burden and loaning the money they keep to a government that spends 4-5% more of GDP than it takes in.

I'm sure there's plenty of articles out there that make these points (and others) in greater detail, john, but the essential points should be theoretically clear to you even at this level: 80 million households making below $80K will rapidly spend whatever additional dollars come there way, thereby creating demand that in turn creates jobs. 1 million americans buy third homes, stock, government bonds, private bonds, and so forth, providing very little incremental demand.

Chris: first off, the Reagan years don't prove that supply side works, because the Reagan years weren't a demonstration of supply-side thinking (spending as a percentage of GDP being higher than than at any time since). The Reagan years proved that deficit spending works, despite whatever thought experiment you may want to push.

As for Q3 growth, you're kidding, right? You aren't seriously saying that Q3 growth was a function of the behavior of 1M households are you? And you certainly aren't forgetting the checks that most households received (not merely those earning the highest incomes that received the highest tax cut)? If the Bush tax cuts were really driving growth, why didn't Q3 repeat in Q4? Why was Xmas spending so dicey? Come on, try harder than that.

Ifthen, i have no idea what you mean about states being bankrupt, but then again, i have no idea what you mean in general....

john, howard, Chris: why matters it who gets the tax cuts etc.

The "rich" are not merely putting the money in a savings account where it trickles down into the economy via loans made on those deposits. Who do you think is driving up those stock prices and other asset prices? It is individuals buying stock, or putting their money into investment funds operated by banks or other financial outfits) who buy the stock on their behalf.

Sure, some of the money is taken out of the stock market at some later time and consumed, but in the aggregate somebody has to buy the stock at a higher price (after having gotten the money to do so from additional "stimulus").

The money that is tied up in financial transactions of various kinds is not available to the "real" economy, and the second-order effects (wealth effect, loaning on increased equity, some gain takeouts) are too little bang out of it.

The "rich" tend to spend more of their (by definition of "rich" ample) discretionary money in first-order unproductive financial schemes than people with unfulfilled material _needs_ (not desires).

One important point about money turnover/circulation is _how_ or _where_ it circulates -- does it go through the hands of "real" businesses who produce "real" surplus value along the way, or is it used to buy and sell stocks? If you are a worker, you will receive your wages and spend most of them, but at the end of the day you will have produced some tangible good or service (or contributed "something" to its production as in most cases it contains other inputs like raw materials, energy, and other people's efforts; in other words, you are adding tangible value). If the money rotates in the stock market and you sit at home unemployed, you are not creating those products that you may.

Of course it is much more complex than that, but in the end it comes down pretty much to this -- how are the flows of money allocated to economic activities.

cm: You seem to think that we should not have a stock market because money used to buy stocks (presumably you mean buy in the secondary market) is somehow wasted. You say money invested in stocks doesn’t go into “real” businesses. A natural consequence of this position is that all corporations should be private (or have no corporations at all). How would these companies raise capital to expand their business activity? They would have to borrow from banks. So capital allocation would be made by mostly by bankers and not markets. This is the system many countries have (e.g. Japan). In the alternative the government could decide capital allocation. This too had been tried and found wanting. After all Socialist countries had to keep their citizens in a virtual prison state, lest they flee to capitalist countries (e.g. the Berlin Wall). So what is your alternative to markets making capital allocations?

A. Zarkov: This is the problem with making simplified arguments, and apparently not putting in enough qualifiers.

I did not intend to dismiss the stock market as a capital allocation device, but raising money happens only when a company issues new stock, either in an IPO or later. Of course the price levels in the stock market contribute to how much they can raise. Stock prices may also have an effect on companies' credit rating to some extent. But then I'm not really sure these things come more out of the fundamentals, and are at best second-order effects of the stock market.

Wouldn't you agree that todays stock _trading_ has been perverted to such an extent that actual investment decisions bear a rather marginal relationship to fundamentals and money allocation principles? What about those fuzzy P/E ratios and other "bullshit factors"? Again, not to dismiss the concept of P/E ratio, but how often do you hear that a given P/E ratio is OK because it is "in range" for the industry sector or in line with other industries?

Trading a stock does nearly squat for giving money to the company. Ask anybody what the purpose of the stock market is, and most people will tell you it's a device to "make money" for _them_, not the publicly traded companies. (This does not prove that it is the _effective_ function of the market, but it shows how people look at it.)

Having said that, the money used for daily stock transactions is effectively tied up in the system, and is not used much for other purposes. The rising stock prices and the trading volumes seem to indicate to me that the amount of money tied up in trading does increase, not diminish.

If you sell some stock, take the money, and spend it on "real" goods and services, things will balance out (and if enough people do this, it will lead to falling stock prices in the aggregate). But typically the money held by institutional investors is turned around and put in different investments, not necessarily just stock. It hardly ever leaves the financial system, and effectively circulates between investors' brokerage accounts, other than a certain share through transaction fees off of which brokers and other bank agents make some nice living, and taxes (!). Even if you sell your stock, somebody else will buy it, either with new money or the proceeds of previous sales. In the aggregate, market valuation can only increase by injecting new money into the trading mechanism.

My (unproven) speculation was that much of the recent stimulus has gone into stock and other asset markets (and that tax cuts for people with a lot of discretionary income it will have just this effect predominantly), and that's one major reason there is nothing much to show on the jobs front.

Based on spotty evidence, for many people after they have settled into a decent enough living standard, the marginal propensity to consume/spend is not really that high, and they will rather invest, except for those who always have to impress themselves and others with the most extravagant and expensive new items, be it clothing, accessories, cars, or whatnot. I'm not judging or saying that any of this is bad, I'm just pointing it out.

cm: “ … but raising money happens only when a company issues new stock, either in an IPO or later.” That’s true, but without a secondary market for stocks the buyers of the IPO would have an extremely illiquid financial asset. Consequently the IPOs would be difficult to sell and not raise much capital. To take an analogous example from the bond world, suppose there were no secondary market for US Treasury bonds. In other words, the buyer has to hold the bond to maturity to get back his principal. In such a world the US government would have pay very high interest rates to compensate for the lack of liquidity of its debt. Secondary markets for stocks are a necessity.

”Wouldn't you agree that todays stock _trading_ has been perverted to such an extent that actual investment decisions bear a rather marginal relationship to fundamentals and money allocation principles?” If you mean that some people and institutions sometimes pay too much for the stocks they buy; I agree. I believe that there are lots of “noise traders” (to use Black’s term) that bid up prices far beyond fundamental values. But as Black points out, they provide valuable liquidity for the market. But this has always been the case; market bubbles are nothing new. Today’s stock trading is not more perverted than yesterday’s. And yes sometimes a stock with an astronomical P/E (like Cisco in 1999) can become a “hot” issue that everyone wants. If you believe that the market P/E is mean reverting than you never want to buy far above the historical P/E. But this is a controversial topic.

“… the money used for daily stock transactions is effectively tied up in the system …” I’m not sure what you mean by “tied up.” The market has a positive bias for its long-term rate of return; this is the reason people invest. Raising prices are an inevitable consequence of increasing GDP. Is money “tied up” in the bond market (which is much bigger than the stock market)? Should companies and governments not issue bonds because it would “tie up” money that should be spent on “real goods?” I don’t think so.

Perhaps I don’t understand you. Let me say that I am more concerned that people are buying residential real estate as an investment as opposed to a place to live and causing a real property bubble. They are paying much more than the fundamental value based on what similar property would rent for. A crash in the real estate market would have severe consequences because you can buy a house with less than a 10% down payment. Thus a lot of people would find themselves with negative equity as housing prices decline. Blame the banks.

A. Zarkov: I was suspecting the thread was dead, but then you replied nonetheless ...

"... secondary market for stocks ... liquidity ..."

I agree with this. With my mastership of the English language my ability to express complex things concisely is perhaps limited. My point was that the extent of money invested in the stock market bears little relation to the actual investment needs of the traded companies, but it is to a large extent (treated as) a big roulette table.

"I'm not sure what you mean by "tied up.""

What I mean is that traders are setting aside funds in the anticipation of buying stocks/bonds/other assets or investment devices. When you want to buy $1000 worth of Cisco, you have to put $1000+ in your brokerage account. You will then (via the broker) give $1000 to the seller of the stock, which may take the money out, pay tax withholdings, and/or reinvest it in another stock. In the aggregate though, a good portion of this money is constantly engaged in trading transactions (during trading hours; afterwards I don't know, presumably it sits in the account idle, or the broker borrows from it to trade in Europe or Asia).

I'm not saying no money should be tied up in this way. My original point was that stimulus that goes to high earners to a good part will be invested one way or the other due to the (postulated) low marginal propensity to spend, and money set aside for stock trading does _not_ circulate in the real , value creating economy.

"Perhaps I don't understand you. Let me say that I am more concerned that people are buying residential real estate as an investment as opposed to a place to live and causing a real property bubble. ..."

Not being a financial person by profession (as should be obvious by now) I did not spend the time to look at how much money is "tied up" in real estate versus the stock market. For the average houseowner at least here in the SF Bay Area what you say is certainly correct. People are (presumably) spending way more on their homes than on other investments. Once you include investment funds that pool money outside of mortgage payers, I'm not so sure anymore.

As I have remarked here and elsewhere, and you may have read it, the real estate market appears to be quite hot again, and the stock market has been trending up. I'm still pretty sure that's where our "stimulus" goes.

What do you think? Any flaw in my reasoning? And please present any numbers that you happen to know.

CM,
I think you are on to something. That the structure of the Bush fiscal policies has led to "asset inflation" caused by the investing class being awash in tax rebates and reductions. This tax windfall is too great for the investing class to manage productively - ie in direct investment such as starting a new company or partering with individuals to create a new company, ideally with an innovative focus.

Instead the money is ending up in rent seaking devices - the stock market (non IPO part) or speculative real estate. These investments while reducing the price of capital have the perverse effect of placing a burden on the economy to produce more rents.
As long as the stimulus lasts the assets appreciate and the cycles prepetuates itself. At a certain point, the stimulus can not continue and as new money fails to come in the investments fall in value and the stimulus is lost.

Little or no job creation and a with a new government deficit left to finance. Not pretty.

The fallacy of this supply side approach is that it disregards all the basic laws of economics. One of the most fundamental principles of economics, after the idea of scarcity, is the notion of diminishing returns. You know, one chocolate bar per day tastes great but 10 chocolate bars per day will make you feel kind of sick.

Lowering the top tax bracket from 70% to 50% will produce an impact on the investment function. But like all other economic phenomena, diminishing returns kick in once you get below 50% marginal rates. Moving the top rate from 50% to 40% has less of an impact and moving from 40% to 30% has less of an impact if not a negative overall economic impact.

It's pretty basic really.

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