Pragmatos

Thus Dean Baker.

The Bear Is Cool: Overcoming Fears of Falling Stock Prices
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The economic data are indeed grim, but the plunge in stock prices need not be a major cause of concern to the bulk of us who have little or no stock. The basic story is that the stock market is paper wealth, just like bonds, dollar bills or other financial assets. The strength of the economy depends on its ability to produce goods and services, not sheets of paper.

    Even though the stock market has fallen by close to 50 percent, the economy still has the same capacity to produce computers and planes, to provide health care and education, and to develop new software and drugs. The economy is every bit as productive after the market collapse as it was before the collapse.

    The plunge in stock prices destroyed paper wealth (lots of it). This is bad news for the relatively small group of people who had considerable stock wealth. However, for the bulk of the population, who own little or no stock, even including mutual funds in retirement accounts, the decline need not be cause for concern, since it has little direct impact on the economy.

    While there is a popular myth about firms selling stock to finance new investment, in reality the stock market has rarely been an important source of investment capital. Therefore, there is little reason to expect that the plunge in stock prices will have a substantial direct impact on investment or the economy.

    There can be a substantial indirect impact of the plunge on the economy. People consume based in part on their stock wealth. Close to $10 trillion of stock wealth has been destroyed in the last year. This implies a falloff in annual consumption on the order of $300 to $400 billion. Unless this demand is replaced, it will amplify the drop in consumption resulting from the collapse of the housing bubble.
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    Unfortunately, the Bush administration refuses to take the economy’s plight seriously, but a large stimulus package will be the first agenda item of the new administration when it takes office in January. If President Obama commits the government to spending another $500 billion a year, or more if necessary, it can offset the loss in demand created by the fall in stock prices and the collapse of the housing bubble.

    Of course there will be other damage created by the loss of this stock wealth. Most importantly, the plunge in stock prices has left many public and private pension funds severely under-funded. The federal government can temporarily allow for somewhat more liberal accounting standards in the case of private funds and provide limited support for state and local governments trying to keep their funds solvent. We can ensure that retirees will receive the pensions they were promised.

    There will be other people who will be hit by the loss of stock wealth, including tens of millions of workers with defined contribution retirement funds. This is unfortunate and points to the problem of the defined contribution pension system. Workers are forced to bear risk to an extent they probably did not recognize and almost certainly did not want.

    One of the many items on the national agenda should be the repair of the private pension system so that all workers have access to a secure form of retirement savings. The plunge in value of retirement accounts should be a painful lesson to tens of millions of hard-working people that they should never trust Wall Street or the politicians it owns.

    However, the most immediate story of the market crash is that it is a redistribution of wealth that goes overwhelmingly in the direction of the less wealthy. The plunge has destroyed claims to the nation’s wealth by the very wealthy in the same way that destroying $10 trillion in counterfeit bills held by mostly by the wealthy would destroy their wealth.

    The key point going forward is to use government spending to ensure that demand remains strong. That way, the rest of the country need not suffer along with the formerly wealthy.

No kidding.

Felix Salmon: Stocks: Recession Bites

Stock markets are a great way for a society to determine where best to allocate its capital. But once in a while we get a reminder that they’re best suited for long-term capital you don’t really need. Because when the recession really bites and you lose your job and you’re forced to fall back on your nest egg, that’s a particularly gruesome time to be forced to liquidate your portfolio.

Dean Baker, of course.

The Post Promotes Nonsense on Deflation

The Washington Post warned us of the evils of deflation in a front page story. The Post … told readers that:

‘Everyone is having these huge sales, and consumers know if they wait longer, the chances of them not having a good selection is fairly small and the chances are that the prices will be lower,’ said Charles McMillion, an economist who runs MBG Information Services. ‘So why buy today? This is exactly why economists are always scared to death of deflation.’

Okay, so let’s parse this one. If prices are falling, why should we buy items today when we can get them for a lower price next month? That’s a real good question.

Has anyone bought a computer in the last two decades? I have run across a few people who have. According to the Commerce Department, computer prices have been falling at the rate of more than 30 percent a year over most of the last two decades. If people felt that it made more sense to wait for prices to drop, we should expect the computer market to have been very weak. That isn’t quite consistent with the explosion in computer sales over this period.
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Now, there is a real sense in which falling prices do pose a problem, but that it primarily with houses, which do not even appear in the inflation indexes. Falling house prices reduce the wealth of homeowners and can put those with a mortgage underwater. This is a huge problem, but it is not the deflation story highlighted by the Post.

It is true that economies that are experiencing economic weakness are more likely to see deflation than other economies. But this confuses cause and effect. The deflation is a symptom, not a cause.

There is one final point worth noting about this issue. The “deflation” highlighted in this article is primarily the result of a plunge in commodity prices. This plunge reversed a sharp uptick in the price of oil and other commodities over the last two years. It is not clear that commodity prices will continue to fall. In fact, it is entirely possible that prices will quickly reverse course and rise sharply from current lows. This would quickly eliminate the Post’s concerns about deflation.

—Dean Baker

Felix Salmon.

Nothing’s unthinkable in this market, not even the idea that you can tie two rocks together and hope that they float.

More likely nationalization of Citi, this weekend, says Salmon.

Update: John Quiggin is pessimistic about Citi (and he’s not so sure about Switzerland).

End of the beginning?

The failure of Citigroup, which looks increasingly likely to happen in the near future, would mark the end of the beginning of the financial crisis. Until now, the prevailing view has been that the crisis and recession will pass in a year or so, after which things will go back, more or less, to the way they were, with a few less financial institutions, and a bit more regulation. A Citigroup failure would put paid to that idea.

Citi is not only too big to fail, it’s too big to rescue with any of the half-measures that have been tried so far. Only outright nationalization is feasible, and that will probably require joint action by a number of governments; Citigroup’s global operations are too big for the US to handle alone. After that, the kinds of tinkering discussed at the G20 last week will be irrelevant. It’s now unsurprising to read (on CNBC!) predictions that all US financial institutions will be nationalized within a year. That’s probably an overstatement: as long as the economy doesn’t really crash, there are plenty of small banks and credit unions that will survive, but few of the big names will be among them.

From dshort.com.

The implied message, I suppose, is that the current crash could easily have a long way to go before it hits bottom. Or not, I suppose.

Barry Ritholtz posted this graph the other day, along with a question: Is the market “cheap”? Not by this measure, anyway.

Obviously we should all be moving into real estate. No, wait…

Dan Ariely, a professor of behavioral economics at Duke, reports on a series of experiments he and his colleagues performed, in which they measure the incentive effects of smaller and larger bonuses.

What’s the Value of a Big Bonus?

What would you expect the results to be? When we posed this question to a group of business students, they said they expected performance to improve with the amount of the reward. But this was not what we found. The people offered medium bonuses performed no better, or worse, than those offered low bonuses. But what was most interesting was that the group offered the biggest bonus did worse than the other two groups across all the tasks.
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When I recently presented these results to a group of banking executives, they assured me that their own work and that of their employees would not follow this pattern. (I pointed out that with the right research budget, and their participation, we could examine this assertion. They weren’t that interested.) But I suspect that they were too quick to discount our results. For most bankers, a multimillion-dollar compensation package could easily be counterproductive. Maybe that will be some comfort to the boards at UBS and Goldman Sachs.

(emphasis mine)

Felix Salmon.

The Return of the $70 Per Hour Meme

You might expect it from right-leaning commentators like Will Wilkinson. You wouldn’t expect it from someone like Mark Perry, who lives in Flint, Michigan. And you certainly wouldn’t expect to see it in the New York Times, from the likes of Andrew Ross Sorkin. But all of them are perpetuating the meme that the average GM worker costs more than $70 an hour, once you include health and pension costs.

It’s not true.

The average GM assembly-line worker makes about $28 per hour in wages, and I can assure you that GM is not paying $42 an hour in health insurance and pension plan contributions. Rather, the $70 per hour figure (or $73 an hour, or whatever) is a ridiculous number obtained by adding up GM’s total labor, health, and pension costs, and then dividing by the total number of hours worked. In other words, it includes all the healthcare and retirement costs of retired workers.

Now that GM’s healthcare obligations are being moved to a UAW-run trust, even that fictitious number is going to fall sharply. But anybody who uses it as a rhetorical device suggesting that US car companies are run inefficiently is being disingenuous. As of 2007, the UAW represented 180,681 members at Chrysler, Ford and General Motors; it also represented 419,621 retired members and 120,723 surviving spouses. If you take the costs associated with 721,025 individuals and then divide those costs by the hours worked by 180,681 individuals, you’re going to end up with a very large hourly rate. But it won’t mean anything, unless you’re trying to be deceptive.

It’s not just the Big Three. NY Times:

A Sea of Unwanted Imports

And for the first time, Mercedes-Benz, Toyota, and Nissan have each asked to lease space from the port [of Long Beach CA] for these orphan vehicles. They are turning dozens of acres of the nation’s second-largest container port into a parking lot, creating a vivid picture of a paralyzed auto business and an economy in peril.