Thursday, October 3, 2013

Crash test dummies

Longtime readers of RtO know that the most important principle of economics was stated 80 years ago by Harry Hopkins: “People don’t eat in the long run, they eat every day.” Any policy that doesn’t enable that goal is bad policy.

There are two other pithy statements that explain the most significant parts of American economic activity since 1980. They are of similar vintage to Hopkins’s encapsulation of the big goal, and they. too, are about goals.

The first came from Treasury Secretary Andy Mellon, who did not regard the collapse of the economy under Hoover as a bad thing. As Hoover wrote, Mellon advised him to "liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate . . . it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

This was delusional. American farmers had been working hard all through “Coolidge Prosperity” and -- according to many a Republican Fourth of July oration -- were the bedrock of American morality and virtue, unlike those wet Catholics and Jews in the city. But farmers were not prospering under Coolidge and Mellon. They were not even eating every day.

The other quotation (coming from memory because I read it in books but cannot find it online today) is from John Rockefeller Sr., and it explains what Mellon was up to: As the stock market swooned, Rockefeller was asked to issue a statement that would calm the nerves of the rich. He, like Mellon, welcomed the crash, because it gave him and his son “the opportunity to purchase attractively priced securities.”

And, really, once you understand those three statements, you can work out the rest for yourself.

Unless you’re an “Austrian.”

 Reaganomics is based on the Mellon-Rockefeller view of virtue: The goal of markets is to transfer more wealth to the worthy: We know they are worthy because they are wealthy. If you worked in one of Mellon’s coal mines, you were unworthy because he did not pay much, and he charged you more at the company store ($1.29 for a bag of flour that the A&P was able to sell profitably to non-Mellon employees in the same town for 75 cents) because that was the tax the wealthy imposed on the immoral. We know they are immoral because god has not deigned to make them wealthy.

The idea is that the wealthy are entitled to appropriate all the labor profit of the workers, because wealth should -- must, even -- flow toward virtue. Here is how that shows up statistically:

Here, from my reporting days, is a small example of how it works in practice in a particular system, in this case Hawaii, where for reasons dating back to the kingdom, most of the land in the desirable commercial districts is in the hands of a few owners, who will not sell to entrepreneurs, although they will lease:

Commercial leases for retail are typically for 10 years, with a reopener to negotiate an extension. As a tax imposed by the wealthy on  the immoral, landlords appropriate the profits of the lessee during the previous decade by demanding such things as “key money” for a renewal.

I first encountered this concept in October 1987, at the end of a long boom on Maui, where a lessee was griping to me that his landlord was demanding $300,000 key money to renew a lease on a small shop on the tourist strip of Front Street. He paid, having no choice; there were no empty spaces on Front Street he could have moved to.

His lease had expired at the end of September. An identical shop, across an alley, owned by the same landlord was up for renewal at the end of October. In between, the stock market crashed, and the second tenant was able to renew without paying any key money.

This is how markets hollow out and destroy the middle class. As an example, it is atypical in two ways: In most states. owning business property in fee is an option for operators; and the crash worked against the aggrandizement of the rich guy.

Usually, crashes work to transfer wealth from workers to the rich. as Rockefeller knew, and that is why rightwingers oppose market regulation. As RtO says, unsupervised markets crash. And the rich then appropriate a greater fraction of all wealth. It is how Ricardo’s Iron Law of wages works in finance capitalism.

It is not true as the “Austrians” and Mellon say, that crashes weed out the less efficient and redeploy capital to more effective sectors. If markets worked -- and to a degree they do -- the thinning occurs during stable and expansionary times, when more efficient firms tend to swallow less efficient rivals.

(This was the subject of the first business story I ever wrote, more than 43 years ago, when I asked why people kept opening small, undercapitalized banks that had no chance of making an operating profit. The story was inspired by my friend Brown Carpenter, who wondered why there were bank branches on three of every four corners at busy intersections.  

(It turned out that three big banks in Virginia were jockeying for dominance, and you could make a quick killing by starting a hopeless bank and selling its corner and accounts to one of the big banks for a heapin’ helpin’ of goodwill.)

That was an aberration of the more benign state of business in which firms with an advantage of location, skill etc. overwhelm less favorably situated firms, often continuing most or all of their operations.

In a financial crash, by contrast, the healthy as well as the sick are carried off. In the Great Depression, a lack of liquidity forced tens of thousands of solvent firms  (all small) to close for inability to collect their receivables. This is less of a problem now, because the New Deal taught the government it could create liquidity and save good businesses. But the healthy as well as the mismanaged are still carried off in a modern crash.

The principal effect of a crash is that people with liquid assets -- rich people -- can buy up assets from the distressed poor for pennies. Thus you get the expansion in one slice of the pie in the chart above.

For example, in 1989 you could buy preferred stock in Dillard’s, the department store, for $2. The stock pays a quarterly dividend of $2, and before and after the crash it sold around par, $25.

That’s a dramatic transfer of wealth, and obviously it does not require any special virtue, skill or hard work on the part of the transferee. All it requires is a pile of free cash.

You will live a loooong time before you hear a rightwinger object to this kind of income redistribution, but eventually, you end up with a wealth allocation similar to that of Russia in 1916 or France in 1788.

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