Worst Corporate Award

I read this hilarious story today.  What isn't hilarious is the idea of bankers speculating with global food prices.  Take a look at this chart:

There is clearly a spike in food prices before the financial crisis, and another peak in 2010. Financial institutions (in the form of index funds) control about 25-35% of agricultural futures contracts:

We estimate that Barclays makes up to £340 million a year from betting, or speculating, on food prices. In the last five years, the amount of financial speculation on food has nearly doubled, from $65 billion to $126 billion.

 I guess you can bet on anything, even if it means taking food from the poor...

Financial Sector Waste

Today's post is more about my thoughts than any data or deep analysis. I've been thinking about the financial sector over the past few days and what purpose it serves. There is one very obvious purpose: to lend. Lending may help consumers buy goods (i.e. cars), homes, and pay for education. Lending also provides capital to small businesses. People can also open accounts and store their money, in return receiving interest payments. All of these are great, and very necessary for a well-functioning economy.

Now for the bad: the financial sector has become very large, and in the process moved away from only collecting deposits and lending. The US financial sector currently makes up around 8% of GDP. There might not be an "ideal" size for any sector but wouldn't it make more sense to put our resources into something more productive? Financial innovation is not real innovation. Paul Volker, former Fed chairman, said it best when he said the last great financial innovation was the ATM. What is financial innovation? Financial innovation is creating derivative products, such as MBS (mortgage backed securities) that helped bring down the US housing market. Is it necessary to create an "Option" so that you can bet on a stock going up or down (does the stock really need another "stock" to bet on itself?). Is it necessary to have a credit default swap market where you can buy insurance for a risky asset? I always thought that a return on a financial product should justify the inherent risk. If you're willing to wager on a risky asset, you take the gain or the loss that comes to you; there shouldn't be another product to guard against the downside.

We shouldn't reward the financial sector for coming up with these useless innovations. Making money out of money is not something a child should grow up wanting to do. Engineers and mathematicians move to the field of finance, it pays more, so high skilled labor will always flow there. In order to keep America innovating and ahead of the rest of the world, we need to stop glorifying the financial industry. Go back to doing your real job, lending and holding our deposits.

83% tax rate?

This is an Economist article that is likely to get a few people riled up:

That is relatively uncontroversial. But their other finding is likely to raise a few eyebrows. They reckon that if the tax system were reformed to make evasion impossible, the top tax rate might be able to rise to as much as 83%—that is, to levels last seen in the 1960s—without hurting the economy. This is because people do not seem greatly to adjust how much they work when tax rates change. Higher top rates may also discourage big earners from spending too much of their time trying to bargain for a larger share of the overall pie.

Yes, it's time to reform the US tax code.

What's wrong with Europe?

If you've been reading the news over the past few months, you may be convinced that the problem in Europe is that certain countries spend too much. Specifically, countries like Portugal, Ireland, Italy, Spain, and especially Greece have governments that are wasteful and spend a lot more than they bring in. There is also a political component to this idea, the stronger countries in Europe (Germany) believe that these other governments should learn to be more fiscally responsible. This uncertainty has led to large increases in the cost of borrowing for these countries (costs that are most likely impossible for these countries to meet).

So is this all true? Do these countries spend too much and is that how they got into this mess? The simple answer: NO!

For those who don't remember (or would like to forget), we experienced a global financial crisis in 2008. When there is a recession, growth slows and as a result government revenue dips. Even if expenditure remains unchanged, there will almost definitely be a deterioration in a country's debt levels. Now some countries were hit harder than others (China, for example, experienced a minimal slow down). The European countries seemed to recover from the crisis weakly and as a result financial markets overreacted by driving interest rates on sovereign bonds higher and higher.

The real question in all of this is not how to get these countries to cut spending, it is how we can help them recover and prosper. Increasing demand is the solution. Increase demand and the rest of the problem will take care of itself. What is increasing demand and how can it be done?

In order to make itself relevant again, Europe needs to look to the emerging market countries like China, Brazil, and India. This may be difficult pill for the former colonizers in Europe and America, but yes, I am telling you to listen to the countries that you left for dead hundreds of years ago. Many of these countries don't have enormous financial sectors (the US financial sector has gone from 4% of GDP to 8.4% in 2008).

Take a look at bank assets as a percent of GDP for the following countries (a simplified measure, but an interesting one nonetheless):

Many of the world's advanced countries need to return to real production. This means spending on research & development and bolstering high technology industries. Until this happens, Europe and the rest of the "developed" world will continue to falter.

Capital Loss

In my previous post, I noted that I wanted to address the capital gains tax and how it could increase US tax revenues. Seems Paul Krugman beat me to the punch yesterday:

So nothing in our history or experience says that unearned income has to be taxed this lightly. It’s not a time-honored principle; it’s a Bush-era innovation, pushed through the Senate, by the way, using reconciliation.

His main point is that capital gains taxes have been higher in the past and that the 15% capital gains tax is a recent innovation. Not only is it a recent innovation, it disproportionately benefits high income individuals.

Source
For the top 400 individual income tax returns in the US, capital gains have averaged over 50% of adjusted gross income from 1992-2006. Changing the US tax code isn't as simple as increasing taxes on wages and salaries. When a top earner makes 60% of their income through capital gains (which is taxed at a lower rate than wages and salaries), the rest of America is at a disadvantage.

The Legend

If you needed a stronger endorsement that austerity doesn't work, take a look at what the Legend says about it:

"It reminds me of medieval medicine," he said. "It is like blood-letting, where you took blood out of a patient because the theory was that there were bad humours.

"And very often, when you took the blood out, the patient got sicker. The response then was more blood-letting until the patient very nearly died. What is happening in Europe is a mutual suicide pact," he said.

Mark my words, European austerity will threaten any semblance of a global recovery in 2012.

Real (Revenue) Talk

There has been a lot of talk recently about government deficits over the past few months. The US and the Euro Area have been mired in political debate about how public expenditures can be cut in order to reduce deficits. Public expenditures include defense spending, pensions, health care, education, etc. However, what has been lost in this debate is the other side of the coin: revenue enhancement. I am not a believer in cutting important expenditures such as health care and pensions; it puts too much of the burden on the working class. Austerity measures are unpopular and, in large doses, simply seem to exacerbate downturns. This is why I wanted to approach the deficit issue from the revenue side: where can governments increase revenues to reduce their deficits? The chart below shows a breakdown of US federal government revenue from 1950 to 2008:

Corporate income taxes have clearly diminished as a proportion of total federal revenue. As a result, corporate profits have exploded:

It seems as though increasing the tax base is as easy as taxing corporations at a higher tax rate. There are other areas to target to raise federal revenues including the capital gains tax (realized capital gains make up around 5% of GDP) and higher income individuals. I will try and address these in future posts.

Welcome

I'm starting this blog to share my views on current economic issues. My goal is to present my point of view on various topics, but to also learn as I blog. I am by no means an economic expert and I won't pretend to be (I will note when I don't completely understand a topic or idea). I would also like to present economic data/charts that I find interesting and any relationships that I see. Comments and debate are welcome. Here's what I'm reading today