The Stock Market

The haste with which the stimulus bill was enacted made it seem certain that the cap-and-trade energy tax, unionization "card check," mortgage "cramdown," and health-insurance nationalization would become law as soon as votes could be taken. It wasn't only the antigrowth implications of these initiatives that had investors terrified in March. It was the sheer recklessness with which they were being stuffed through the legislative pipeline under the Rahm Emanuel doctrine of never letting a good crisis go to waste. The crippling uncertainty of it all was making that crisis worse.

Since then the market rally has tracked the demise, one by one, of all these initiatives, because investors could see that a political environment that had been far out of equilibrium was quickly finding its balance. Republicans stayed unified in their opposition, while in every case key Democrats lost their nerve.

Readers may now understand why economist Brad DeLong likes to call Donald Luskin "the stupidest man alive." Because in the universe most of us are living in, the stock market's nine-month rise came during a period in which health care reform steadily came closer and closer to passage. The high for the year came at almost exactly the same time the Senate was voting on its version of the bill! It was only after Scott Brown won election in Massachusetts and the Democrats lost their 60 vote majority that the stock market started to plunge. In other words, once the super-majority vanished, throwing the passage of all of Obama's initiatives into doubt, only then did Wall Street get nervous.

Luskin's argument is that Brown's victory presages a turn to anti-Wall Street populism by both Democrats and Republicans that the investor class finds distressing.  But there's a much much simpler explanation than politics to explain the stock market rally. Since March, the economy has stabilized. The monthly rate of job losses has declined dramatically. GDP is growing again. The prospect that Wall Street's biggest banks would be forced to declare bankruptcy has receded. All these things, whether you like them or not, were in part the result of Obama's policies. Most non-ideological economy observers -- the kind of outfits that sell their analysis to discerning customers rather than try to get quoted on Fox News -- peg the stimulus as responsible for at least one to two points of GDP growth and for keeping unemployment from surging even higher than it already has. And as anyone one degree to the left of Luskin appreciates, Obama's policies towards the financial sector have been highly reassuring to the investor class -- which explains both the stock market rally and widespread bipartisan political anger.

Remember "the new economy"? In the second half of the 1990s, after years of stagnation, the U.S. economy briefly boomed. Members of the New Democrat wing of the Democratic Party, associated with the Democratic Leadership Council (DLC) and the Progressive Policy Institute (PPI), made a number of claims.

First: The source of the boom was not a bubble associated with tech stocks, but rather a permanent increase in U.S. productivity growth produced by the information technology (I.T.) revolution. Second: Foreign money was pouring into the U.S. as a result of well-informed expectations that the U.S. would lead the world in economic growth for a long period to come. Third: Increased inequality in the U.S. was a result of the global market rewarding skilled Americans at the expense of unskilled Americans, and could be cured by more higher education.

Something like this was the cheerful and optimistic New Democrat party line in 2000, the last year of the Clinton administration. How do things look from the perspective of 2010?

It is now clear that the boom of the second Clinton term was driven by the temporary tech stock bubble. It did not mark the beginning of a "new economy" fundamentally different from the old.

It is true that official statistics showed a trend toward a higher level of U.S. productivity growth in the late 1990s and 2000s than in the period of prolonged slow growth from the 1970s to the mid-90s. But Michael Mandel and other economists (pdf link) have argued that government statisticians have exaggerated the rate of productivity growth in the Clinton and Bush years by mistaking the falling prices of imported ingredients from low-wage countries like China for gains in productivity on U.S. soil.

Between 1997 and 2007 U.S. productivity growth might have been overstated by as much as 20 percent. If this revisionist critique is right, then actual U.S. economic performance, when the stock and housing bubbles are factored out, has been much worse than anyone would have believed a few years ago. The illusory wealth generated by overpriced tech stocks and houses temporarily obscured the grim picture, but now its depressing outlines are becoming clear.

What about the claim of neoliberals in the 1990s that foreign money was pouring into the U.S. based on rational expectations of a permanent, technology-driven American boom? That pet theory of the New Democrats has been discredited by events (pdf) as well.

Investments in emerging markets have done better than investments in the U.S. in the 2000s. China and Japan have continued to buy U.S. debt, not because they are impressed with Silicon Valley's growth potential, but in order to cripple American manufacturing by keeping the dollar artificially high and the yuan and the yen artificially low. Their debt purchases are part of their strategic industrial policies on behalf of their own export-oriented manufacturers, not a vote of confidence in future American economic dynamism.

Another New Democrat myth, endlessly repeated by Clinton in the 1990s and by President Obama today, is the theory of skill-biased technical change (SBTC). SBTC held that the growing polarization of U.S. society was the result of irresistible global technological forces, not local factors with political causes, like the de-unionization of the American labor force or the inflation-caused decline of the minimum wage.

The New Democrats and like-minded Republican conservatives told us again and again that the huge gains going to CEOs and investment bankers reflected the premium attached to skills in the global "new economy."

Even in the 1990s, this explanation made no sense. After all, the skills of CEOs and investment bankers have undergone no significant change in the last half century. If the SBTC theory had been correct, you would expect scientists and engineers and office-tech specialists to be making the great fortunes, not bankers and corporate managers.

What's more, you'd expect the same forces -- technology, globalization -- to produce the same explosion of incomes at the top in similar countries. But other industrial countries, apart from Britain (dominated, like the U.S., by its swollen, parasitic financial sector), have not seen anything like America's growth in inequality.

As the economist Brad DeLong points out, "The big rise in inequality in the U.S. since 1980 has been overwhelmingly concentrated among the top 1 percent of income earners: Their share has risen from 8 percent in 1980 to 16 percent in 2004. By contrast, the share of the next 4 percent of income earners has only risen from 13 percent to 15 percent, and the share of the next 5 percent of income earners has stuck at 12 percent. The top 1 percent have gone from 8 to 16 times average income, the next 4 percent have gone from 3.2 to 3.7 times average income, and the next 5 percent have been stuck at 3 times average income."

DeLong notes that this pattern does not fit the story of college-educated workers in general deriving a wage premium from the new economy. To make matters worse for the new economy school, from 1998 to 2007, earnings for Americans with B.A.s were practically flat after inflation while the youngest college graduates suffered a slight decline in real wages.

Here's what the New Democrats of the DLC and PPI who chattered enthusiastically about the "creative class" of "knowledge workers" in the "new economy" failed to understand: The main jump in income inequality took place in the 1970s and the 1980s, before the alleged new economy created by the tech revolution.

The relative decline of wages at the bottom had little or nothing to do with technology or the global economy and everything to do with the weakening of the bargaining power of American workers vis-à-vis their employers thanks to declining unionization, an eroding minimum wage and the flooding of the low-end labor market by unskilled immigrants from Latin America, both legal and illegal.

Having misdiagnosed the problem, New Democrats, including Clinton and Obama, have consistently prescribed the wrong medicine: sending more Americans to college. According to the Bureau of Labor Statistics, most of the occupations with the greatest number of openings in the foreseeable future require only a high school education or an associate's degree, not a four-year B.A.

The most effective way to raise wages at the bottom would be to increase the bargaining power of workers, by unionizing the service sector and by tightening the labor market through restricting unskilled immigration. That would probably spur genuine productivity growth over time as employers substituted technology for more expensive labor.

But more widespread unionization is opposed by the corporate sponsors of the New Democrats. And while progressives spend oceans of ink on the effects of outsourcing on the small number of workers in the manufacturing sector, they are silent about the effects of mass unskilled immigration on the much greater number of low-wage workers in the domestic service sector.

The experience of the last decade discredits the claims of New Democrat neoliberalism. But it does not necessarily vindicate progressives. Many progressives assumed along with the neoliberals that the economy really was growing rapidly and that business in general was robbing labor of its fair share of what were believed to be huge gains.

One of the few progressives to question this orthodoxy was James K. Galbraith, who argued that most of the spike in inequality was explained by a small number of Silicon Valley and Wall Street tycoons. The crash made it clear that a significant amount of the wealth of the super-rich in the 2000s had in fact been imaginary all along.

The grim truth is that the new economy promised by the New Democrats never materialized. Yes, we have the Internet and iPhones, but the gains in productivity that have resulted so far from I.T. have been pretty minor compared to the results of the introduction of the steam engine, electricity and the internal combustion engine.

Yes, you can use Google to shop for items and order them via Amazon.com, but the factories that make them and the ships and the trucks that bring them to you would have seemed familiar to engineers in the 1950s.

The moment when much-hyped alternative energy sources like wind and solar become competitive with fossil fuels and nuclear energy seems to perpetually recede into the future. The all-renewable energy sector is 30 years away -- and always will be. A decade ago, there was a national debate about outlawing germ-line engineering of humans, on the expectation that large-scale genetic engineering was imminent. Instead, progress in biotechnology has been slower than opponents feared and supporters hoped.

The glib New Democrats who chirped in the 1990s about the wonders of the new economy were dead wrong. If ever a school of political economy has been discredited by events, it is Clinton-era neoliberalism. And yet the Obama administration's economic team is made up of recycled Clintonites, the very people who misunderstood the actual trends in the U.S. and global economy for the past 20 years.

An acknowledgement of their mistakes would be in order. But they would first have to recognize that they were indeed wrong about the central issues of our time.

In the Great Recession of 2008-09, companies are going a step further. They’re using this sharp downturn to cut payrolls even below where they were when times were good. Outsourcing abroad, setting up shop in China and elsewhere, contracting out, replacing people with software and automated machines -- they're doing whatever it takes to get payrolls down so earnings bounce up.

Caterpillar earned $404 million in the third quarter, or 64 cents a share. Analysts had expected only 5 cents. Caterpillar’s stock is up 165 percent since March. How did Caterpillar do it? Not by selling more bulldozers. It did it by cutting more than 37,000 jobs.

The result, overall, is an asset-based recovery, not a Main Street recovery. Yes, the economy is growing again, but the surge in productivity is a mirage. Worker output per hour is skyrocketing because companies are generating almost as much output with fewer workers and fewer hours.

The Fed, meanwhile, has become an enabler to all this, making it as cheap as possible for companies to ax their employees. Money costs so little these days it’s easy to substitute capital for labor. It’s also easy to buy up foreign assets with cheap American money. And it’s now blissfully easy for Wall Street to borrow money almost free and buy all sorts of interests in foreign assets, especially commodities. That's why we're seeing the prices of foreign commodities and other assets go through the roof.

At the same time, the Treasury continues to be fixated on keeping banks afloat. The administration's mortgage mitigation efforts are lagging. Small businesses are starved of credit. The White House has announced a "jobs summit," which is better than nothing but not nearly as good as pushing immediately for a larger stimulus, a new jobs tax credit, and a WPA-style jobs program.

The Fed and the Teasury have, in effect, placed a huge bet on a recovery driven by asset prices. That’s a bad bet. The great disconnect between the stock market and jobs is pushing stock prices way out of line with the real economy. This isn't sustainable.

No economy can recover without consumers. Yet American consumers, who constitute 70 percent of the U.S. economy, are facing mounting job losses as well as pay cuts. They’re in no mood to buy and won’t be for some time.

Where is this heading? No place good. Without a major shift in policy -- both at the Fed and in the White House -- the economics point to a big stock-market correction and a double dip. The politics point to substantial losses for Democrats next year.

Investment advice from Ann Coulter? In what alternate reality does that make sense?

Wolcott finishes up his riff with a nice flourish:

...If it were a Republican president in the White House and the Dow was hitting such highs the same week of the 20th anniversary of the fall of the Berlin Wall, the hosts and panelists at Fox would be waving little American flags celebrating the market boom as a fitting toast for the triumph of Western capitalism over communism and a rebuke to naysayers and doubters with souls so gray and faith so brittle.

Meanwhile, if you're looking for economic news a little more grounded in the real economy than the ebbs and flows of the stock market, the weekly jobless claim numbers (seasonally adjusted) for the first week of November dropped again, taking the four week moving average to its lowest total in a year. That is good news, unless you're Fox Business, in which case it is probably yet another reason to stock up on gold.

McArdle's thesis is especially provocative, because most market watchers expected that the Fed's announcement that it would keep rates close to zero indefinitely would juice the market. But there's no doubt -- the timing of the market collapse and the news from the Fed were highly correlated.

But there's one other thing that happened about the same time the market collapsed. Noam Scheiber published a post demolishing the absurd thesis that the (then-ongoing) rally was a reflection of Wall Street's enthusiasm that Tuesday's election results represented a repudiation of the Obama "agenda" and "stopping the agenda is good for the market."

As Scheiber writes, "the reasons why this theory is utterly ludicrous are almost too numerous to catalog." You don't have to go much further than contemplating what a six month long market boom implied for Wall Street's faith or lack thereof in the Obama agenda. But moments after Scheiber's post, the rally suddenly ran out of steam, suggesting that, if investors had believed such nuttiness, they no longer did, probably because they had just read Scheiber. Which I guess, perversely proves the original thesis!

The truth, as my readers love to inform me, is that intra-day movements of the stock market are rarely explainable by any one factor, and we shouldn't waste precious blog-space trying to figure them out. But longer term movements are worth some head-scratching, which leads to a consideration of a troubling column published in Slate yesterday, by Dan Gross, "The Mystery of the Rising Stock Market."

Gross argues that the strong performance of the U.S. stock market since March has little to do with the prospects of the U.S. economy, and everything to do with the return to relative health of the global economy.

The Dow, the S&P 500, and the NASDAQ are primarily indices of large U.S.-based companies, not main street businesses: more Davos than Chamber of Commerce. These increasingly cosmopolitan firms have been busy globalizing and expanding their operations overseas. In 2006, according to Standard & Poor's, 238 members of the S&P 500 broke out revenues between U.S. and non-U.S. sales. These companies notched about 43.6 percent of sales outside the United States. For large companies that had already saturated the U.S. market, the home market was something of an afterthought. In the second quarter of 2007, 66 percent of Coca-Cola's (KO) beverage business came from outside North America.

This is a point I've been making here since at least last April, when I noticed that the companies that were doing best at resisting the slowdown in the U.S. were the companies that had the most exposure overseas. But while global growth might be good for stockholders and company execs, it's not clear how it helps everybody else.

Gross:

GM's sales in China are rocking. In the first nine months, the company sold 1.3 million cars in China, including more than 181,000 in September. By contrast, GM in the United States in the first nine months sold 1.5 million cars in the United States, down 36.4 percent from the year before. And in September, GM sold just 156,673 cars in the United States. That growth in China is good for GM's shareholders and for some of its executives. But since most of the cars sold in China are produced there, with parts produced by suppliers in China, rising sales in the Middle Kingdom won't translate into jobs for unionized workers in the Middle West.

Before the global recession, there was much talk about whether Asia and the West had "decoupled" their economies. What some of us might not have realized was that the U.S. stock market had also decoupled from the U.S. economy -- and run off with Asia.

Eight months ago it looked as if Wall Street was in store for strong financial regulation -- oversight of derivative trading, pay linked to long-term performance, much higher capital requirements, an end to conflicts of interest (i.e. credit rating agencies being paid by the very companies whose securities they're rating), and even resurrection of the Glass-Steagall Act separating commercial from investment banking.

Today, Congress is struggling to produce the tiniest shards of regulation that would at least give the appearance of doing something to rein in the Street.

What happened in the intervening months? Two things. First, America's attention wandered. We're now focusing on health care, Letterman's frolics, and little boys who hide in attics rather than balloons. And, hey, the Dow is up again. The politicians who put off Wall Street regulation for ten months knew that the public would probably lose interest by now.

Second, the banks keep paying off Congress. The big guns on Wall Street increased their political donations last month after increasing their lobbying muscle. Morgan Stanley's Political Action Committee donated $110,000 in September, for example, of which Democrats got $43,000.

Official Wall Street PAC donations are piddling compared to the tens of millions of dollars that Wall Street executives dole out to candidates on their own (or with a gentle nudge from their firms). Remember -- the Street is where the money is. Executives and traders on the Street have become the single biggest sources of money for Democrats as well as Republicans. And with mid-term elections looming next year, you can bet every member of Congress has a glint in his or her eye directed at the Street.

That's why the President went to Wall Street to raise money Tuesday night, gleaning about $2 million for the effort. He politely asked the crowd to cooperate with reform -- “If there are members of the financial industry in the audience today, I would ask that you join us in passing necessary reforms" -- but those were hardly fighting words. It's hard to fight people you're trying to squeeze money out of.

Which is the essential problem.

Ken Feinberg, the President's "pay czar" came down hard on executive pay yesterday, for those banks still collecting money under TARP, as well he should. But Feinberg isn't trying to pass new financial reform legislation, and TARP no longer covers several of the biggest banks with the highest pay and bonuses -- although they're still getting subsidized by the government with low-interest loans.

Wall Street and the Treasury want us to believe that the TARP money will be repaid to taxpayers, but Neil Barofsky, the special inspector general keeping watch over TARP, said yesterday that just 17 percent of the TARP money has been repaid, and “[i]t’s extremely unlikely that taxpayers will see a full return on their investment." Later he told a reporter that it's unlikely "we'll get a lot of our money back at all."

Brian Griffiths, the Goldman international adviser who told us inequality is good for us, doesn't know what he's talking about. America is lurching toward inequality once again, led by the financial industry. The Street is back to where it was in 2007, but most of the rest of us are poorer than we were then -- largely due to the meltdown that occurred because Wall Street overreached. The oddity is that we bailed out the Street, including Griffiths and his colleagues, but apparently won't even be repaid.

And now that Griffiths et al. know his firm and the other big ones on the Street are too big to fail, he and his colleagues will make even bigger gambles in the future with our money.