Originally published April 19, 1982
I feel tempted to say a word about one part of George P. Brockway’s “Why Deficits Matter” (NL, March 8). Brockway draws a distinction between speculation and productive investment that is entirely misleading.
Of course, there is a difference between a purchase of a share of stock on narrow margin and a purchase of the same stock out of savings. The first is speculation, the second you might call investment, depending on the stock. The economic effect, however, is the same. The market does not distinguish where the buyer of a security got his money from. In fact, it has no way of knowing. In either case, the seller of the stock can do three things with the money he gets-consume it, hoard it, or put it into some other investment. Few sellers of stock consume their principal. Not much idle money is held at today’s interest rates. The chances are overwhelming that the seller of the stock, whoever he is, will put his money into another investment.
If that “new investment involves the creation of brick and mortar, it is directly productive. If it just leads to the purchase of an existing security, the same set of choices confronts each successive seller. Eventually, the money will find an outlet in directly productive new investment, unless it is consumed or hoarded. In the process, stronger demand for securities reduces interest rates and stock yields, reduces the cost of capital to investors, and in that way also stimulates investment.
In conclusion, I want to note that while I fully agree with the statement in the title that deficits do matter, I find the entire article so one-sided that in limiting my comments to the point I have made I do not mean to imply agreement with any of the rest of it.
Washington, D. C. HENRY C. WALLICH
Member of the Board of Governors
Federal Reserve System
George P. Brockway replies:
To comment on Governor Wallich’s interesting letter I must try to summarize points I made in “Why Speculation Will Undo Reaganomics” (NL, September 7, 1981). There I proposed definitions of gambling, speculating and productive investing that, I believe, disclose the different economic effects of the three kinds of activity.
In brief, gambling is a zero-sum game that produces nothing but the players’ pleasure or despair. Speculating is not a zero-sum game: Over very long spans of time all who participate can gain, though some will no doubt gain more than others, but speculating is like gambling in that it only rearranges wealth that already exists. Productive investing is like speculating in that it is not a zero-sum game, but it differs in that goods and services are produced. It should be emphasized that all three activities are risky; consequently risk is not a useful criterion for distinguishing among them, though it is the one ordinarily used.
Governor Wallich’s view, which is the standard one, is that such distinctions are idle because ultimately the results of speculating go into consumption, hoarding, or “bricks and mortar.” This, I should contend, is one of those instances in which Keynes’ remark (“In the long run we are all dead“) is appropriate. Holland’s tulip mania increased in virulence from 1615-37-…It took nine years for the South Sea Bubble to burst. The Great Bull Market lasted six or eight years. Some of these speculative frenzies might, in Governor Wallich’s terms, be classified as hoarding or consumption; but they were not productive investments. They absorbed, and ultimately destroyed, vast sums that could have gone into productive investments.
More important than all this is the role of the stock and commodities markets. Governor Wallich says that “Eventually, the money will find an outlet in directly productive new investment unless it is consumed or hoarded.” The imagined event has to be a long time coming. Fewer than 1 per cent of the transactions on the stock and commodities exchanges have anything to do with productive new investment. Professional traders can and do spend their whole lives buying and selling without ever touching a productive new investment. Insurance companies and endowment funds tend to shy away from productive new investments. Investment bankers (so called) are now mainly concerned with mergers and takeovers. A very large nonproductive tail keeps the productive dog off balance.
I’m afraid it simply is not so that “stronger demand for securities reduces interest rates … and … stimulates investment.” This may be what the theory calls for, but it is flatly refuted by the present situation, when both exchange transactions and interest rates are at all-time highs. The “stronger demand” is a speculative demand, and it attracts money away from productive investment.
To cite an example, U.S. Steel abandoned plans to update its mills and borrowed $3 billion to acquire Marathon Oil. It would be fantasy to suppose that the happy Marathon stockholders, having unloaded at the top of the market, have not been encouraged to bid up the shares of other companies thought susceptible to takeover. There is nothing productive about this. Moreover, the $3 billion U.S. Steel borrowed has surely helped to keep the interest rates high. It is the same with margin accounts, which soak up available funds and thus help keep both securities prices and interest rates higher than they would otherwise be.
I agree with Governor Wallich that “The market does not distinguish where the buyer of a security got his money from.” For this reason (among others), I would not try to prevent speculation. But I would shut down margin accounts (as has been done before). I would see what could be done to discourage borrowing to finance mergers. And I would not encourage a hundred speculative transactions (as the low capital gains tax does) in the bumbling hope of stimulating one new productive investment.
As to the fact that the rest of my article on deficits was one sided, I admit the soft impeachment. If you have a reasoned conviction, I’d think it irresponsible to pretend to what is called a “balanced view.”