Tuesday, December 22, 2009

The greatest threat to capitalism

For many people, this is a time of year for reflection (instead of year ahead forecasts which I already touched upon here). So let me share with you my personal concerns about those who are less fortunate.

A growing class-based chasm?
This is a theme that I have expressed concerns about in the past. A fraying social fabric and a threatened middle class which endangers political stability.

Who is in the middle? Consider the following video, which depicts income distribution in the United States. While there are some inaccuracies, median household income is about 50K, not 40K, it does make the point about inequality.

The social elite these days is mostly Wall Street. Consider the I-am-more-deserving-than-you attitude in this Barrons article when bankers were asked as to whether they owed a social debt to society because of the bailouts (if you don’t have a Barrons subscription, see some excerpts here).

The greatest threat to capitalism are the capitalists themselves
In the past, this kind of let them eat cake mindset has led to peasant revolts. Already Moody’s has picked up on this theme and warned of social unrest. The UK is calling the bankers’ bluff to pick up and move elsewhere, but the US has caved to virtually every of the bankers’ wishes. Yves Smith at Naked Capitalism has suggested that the proper response by the UK government would be a combination of harassment or punitive tax policy for the likes of Goldman or any other investment bank who leave.

Policy bias favoring Wall Street is already institutionalized, the New Republic has an interesting article which indicates that the US may not be able to revitalize its manufacturing base because business schools are turning graduates oriented towards finance, not operations or manufacturing.

What’s more, no less than former Federal Reserve Chairman Paul Volcker has picked up a pitchfork and appears ready to join the peasant revolt. Joseph Stiglitz believes that banking troubles are worse than pre-Lehman crisis.

Others, like John Hussman, are outraged at the bailouts:

It's clear that financial institutions have made a mad dash to repay TARP money in hopes of being able to pay year-end bonuses, but what is not so clear is what happens after the year actually ends. Various policy makers (particularly Ben Bernanke, who is currently up for reappointment) have begun to take on a self-congratulatory tone, suggesting that the recent crisis is not only behind us, but that it has been resolved at a profit. What is not evident from these comments is how small these “profitable” inflows have actually been, in relation to what has been spent.

I will be convinced that the crisis has been resolved at a profit when the Fed disgorges the $1.5 trillion in Fannie Mae and Freddie Mac securities it has bought for us, and if the U.S. government does not end up having to bail those securities out because the cash flows from the underlying mortgages prove inadequate. Having no such assurance, the smug “mission accomplished” remarks of Bernanke and Geithner are reminiscent of a veterinarian who walks out of the operating room saying “I saved the life of your rabid dog … by giving it the vital organs of your children.”

The rebirth of the American Dream, or end of Pax Americana?
Most people who read a financial blog like this belong in the top 10% and a considerable in the top 1%. I believe that those of us who are in the top distribution of society must realize that unless America acts to restore the American Dream and dismantle the nascent class system that was formed with financiers at the top, the end of Pax Americana is at hand.


egnard said...

The more important question maybe, is capitalism is a threat to democracy? Can a democracy exist without a middle class? As an example consider the health care debate. Given the erosion of the middle class and the battle for universal health care, it is troubling that there isn't more unrest in my opinion. But with corporate controlled media the less fortunate are being told that it is in their interest that large, for profit health care organizations would get a bad deal if they were to get the health care system that should be a basic right in a developed nation. And the debate is being swayed by corporate health care interests in Washington. Is this democracy?

Kieran McCarthy said...

I'm surprised that more investment managers don't factor this in when they look at long-term valuations. There is considerable risk that not only will there be higher taxes intermediate term, but also that political parties everywhere from Spain to Ireland to England to the US take on a decidedly anti-corporate, anti-banking tone to keep their jobs. It may be impossible to predict what threads will develop, but I doubt that they will help corporations return to record profitability

Unknown said...

If income inequality is the problem, then what are the solutions available from a public policy perspective (short-long term) to reduce these inequalities. More importantly, can policy makers achieve the necessary buy in from to meet their desired ends.

Although it is always in vogue to bash bankers in Washington, I doubt their sincerity in taking proactive steps to correcting these imbalances or more likely taking the wrong steps.

You point out that many of the business school graduates would rather move into finance then operations/manufacturing. As manufacturing has moved off-shore the demand for these positions has fallen including their wages. As a student paying $50,000/year for Stanford University, it would be in my best interest to target an in-demand position. Finance has filled the gap and wowed students with the idea they could be driving a BMW 5-series at the age of 24 and be financially secure by 30.

Income inequality is just a result of a much deeper social and economic problem, that needs tackling.

Some questions I would like answered:
-How do companies convince MBA graduates to take a lower salary in operations then finance?
-What groups (U.S. government, major exporters, universities) need to be coordinated to undertake this change?