Uncommon Sense

May 27, 2010

Capitalism Run Aground

Right-wing bloviators are fond of saying “we shouldn’t tax the rich because they are the ones who create the jobs.” They don’t specify whether the jobs are good jobs or not or whether they are overseas instead of here, but let’s look at the basic claim. This claim reminds me of the platitudes served up when I was in grade school and there are plenty of reasons to believe this is just protective camouflage for what is really going on.

I remember being in grade school (the late 1950’s maybe) and we took a field trip to the Pacific Coast Stock Exchange. We were being taught about how the stock market worked. Basically the stock market was a clearing house for investments in various businesses. It worked like this: businesses “sell” part of their company in the form of stock certificates. Investors buy those “shares” in the company as a way to invest their money for a profit. The investors rarely would have enough money to by a significant interest in any one company but they can afford to buy a tiny fraction of even many companies in the form of one or more of these shares. The businesses then use the money from the sale to expand or modernize the company. If the company did well, it took part of its profits each year and paid a small bonus (a dividend) to their stockholders and, if the company did well over time, the stock became more valuable, and an additional profit could be made when it is sold (but low, sell high). Over time, the stock market has been a source of excellent returns for the investors and has been a boon for business.

That’s how it was explained to grade school kids then and, unfortunately, this is what most adults believe is going on now. Except it is not true.

In 1929 the New York Stock Exchange had a massive collapse, leading to investor suicides and a world-wide depression that lasted over a decade. Businesses collapsed and millions of people were thrown out of work and into poverty. The people blamed for this debacle were “speculators.” Speculators were people who looked at stocks as something that had value outside of the small slice of the company they represented. People “talked up” various “securities” to the point that people thought they were very desirable in and of themselves and a bidding race was on. Stock prices spiralled higher and higher. But eventually people realized they were paying many times what their shares were actually worth and began to sell off these bad investments which lead to a stampede which dragged down the values of all of the stocks to the point that a great many were worthless.

This is the problem with the Stock Market in general. It’s focus is not on the companies themselves but in the return on the stock certificates instead. So, why is this still a problem? Well, in the 1930’s the word “speculator” was used as a curse word, but we have never really done anything to curb speculation, in fact we have glorified it. In the 1970’s, the relative amount invested in regulated stock exchanges worldwide that corresponded to real economic value was 90% with about 10% of the money invested was speculative. By 1990, these two numbers were reversed and the percent of the money invested in all of the world’s exchanges that was merely speculative went up from there. In 1994 it was up to 95%. What it was before the 2008 crash we may never know.

And herein lies the problem. The basic system is receiving feedback that is skewed all out of recognition. In the old days, if a company did well, had steady growth, good labor relations, and good prospects for the future, it’s stock was considered a good value. But speculators are not interested in investments in good companies, they are interested in good profits. So, companies who don’t make good short-term profits, get hammered by the market. The shares of that company are devalued and the reputation of the company suffers along with its ability to borrow money, etc. A company which makes a great profit, say 12% annually, can get hammered if Wall Street analysts think they should have made 15%. In other words, actual performance, even great performance means little next to the virtual performance expected by speculators.

You have probably noticed that CEO pay has grown astronomically while working class wages (adjusted for inflation) have been stagnant for at least 40 years. Why is this? It is because if a CEO delivers short-term profits to speculators, he is rewarded by an increase in the companies stock value, some of which he is usually paid with (in actual stock or options to buy shares at a lower price). The better the short-term performance the better the pay for the CEO, to ridiculous levels. If the CEO doesn’t deliver quarterly profits, he is likely to be fired and replaced with a CEO that can. In other words, CEO’s have a rewards structure that has nothing to do with long term viability and success of the company and everything to do with delivering profits to speculators.

Top this with the right-wing bloviators claim that “regulation stifles innovation!” (And they say this as if it were a bad thing!) While the monied interests were slowly chipping away at federal financial regulations from the Reagan era to the Clinton era, the stock market slowly innovated with wonderful instruments like penny stocks, micro-trading, derivatives, and collateralized debt obligations. Some of these “innovations” were not really innovations, derivatives were just tools of the commodities markets used in financial markets, but the uses to which all of these were put were simply to fuel speculation. Basically because stock market people are paid by the transaction, the more transactions and the more money involved in them, the more money they made. Again, the wrong feedback for a health economy.

Regulation is supposed to stifle innovation! That is its purpose. It is supposed to stifle stupid, purposeless innovations and it is time we had more of it. What we need stifled is speculation!

In 1972, speculation was primarily in currency and Nobel Laureate economist James Tobin, suggested that there be a tax on all short-term currency conversions. This was referred to as the Tobin Tax and was, of course, never implemented. It is time we had another look at the Tobin Tax, this time applied to all monetary transactions that do not involve goods. This or some other idea has to be found to stifle speculation to force it to reasonable levels.

So, the next time someone claims “we shouldn’t tax the rich because they are the ones who create the jobs,” challenge them to prove it. The mere fact that the very rich have an ever increasing fraction of the nation’s total wealth indicates that they are not doing as claimed. Or if they claim, “regulation stifles innovation” ask them to identify any innovation in, say, the financial domain in the last 20 years and ask them to explain how that innovation was a benefit to society.

We should tax the rich, so they are paying their fair share and because they are ruining the economy with their excess funds and we should stifle innovation, stupid speculative innovation first, please.

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