Archive

Tag Archives: Speculation

Originally published September 3, 1984

THE Continental Illinois and the Financial Corporation of America bailouts, although different in nature, have one glaringly obvious lesson that everyone sees and even talks about endlessly yet refuses to think about. The lesson is that this bank and this thrift institution were too big to be allowed to fail, just as Chrysler and Lockheed were before them.

Everyone knows and says that. Everyone has enough mathematics to know as well that if Financial Corporation of America, the nation’s 12th-largest organization of its kind (counting both commercial banks and thrifts) is too big to be allowed to go under, there must be at the very least 11 others in the same category. Clearly, Citibank and Chase and the rest did what they did in South and Central America because they were confident that no matter what happened, they would not be allowed to fail, and in the meantime they could make a lot of very big loans at very high interest. Still, only a few people – like William Wolman, editor of Business Week – dare to say that in the end many, if not most, of these loans will be repudiated, and that Uncle Sam will, in one way or another, pick up the tab.

This may not be so bad in the event as it looms in contemplation. You have probably been struck by the fact that an awful lot of money is involved, and that no one seems to be certain exactly how much; yet whatever the amount, it is not overwhelming in relation to our national debt or even to our annual Reaganomic deficit. When Uncle Sam picks up the tab, we won’t be bankrupted. Indeed, we may be sure that the whole operation will be handled in such a discreetly indirect way that we will not notice it. There is a time for flamboyance and a time for discretion, and bankers are very good at telling which is which. Have you heard anything about the Polish loans lately?

More than money is at issue here. There has been talk about having someone – the Federal Reserve Board, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, or some private insurance company – look more closely over the bankers’ shoulders. New laws are being proposed, and complaints are being made that old ones are not being enforced. The bankers are not much concerned, though, because they know that not much can come of it.

As long as the big banks are substantially free of regulation on the interest they can pay, they will be free of significant regulation elsewhere. Walter Wriston, the recently retired chairman of Citibank, who may be said to have initiated the current state of affairs with the dictum that countries don’t go bankrupt, now says that bankers are too proud to conduct their business in the expectation that the government will rescue them from their mistakes. He is undoubtedly as reliable one time as the other.

Early last month, the New York banks had a little war to see who could pay the highest interest on certificates of deposit. The war was apparently started by Manufacturers Hanover as a macho gesture, to show that current rumors of its weakness were false. An ad for Citibank, and several others, at one stage quoted an effective annual rate of 13.6 percent on one-year CDs. That sounded dandy (and was) for those with the cash to take advantage of it.

You may wonder how, with a prime rate that was then 13 per cent, Citibank could pay 13.6 per cent for its money. Mr. Micawber would have said: “Annual income thirteen per cent, annual expenditure thirteen and six-tenths, result misery.” It’s pretty hard to fault Mr. Micawber’s reasoning. Are bankers alchemists after all?

AT LEAST three things are going on behind the scenes. The first is that the bankers are practicing alchemy-up to a point. When they increase their reserves by selling you a CD for $1,000, they are able, very conservatively, to increase their lending by $5,000. A prime rate of 13 per cent on $5,000 earns them $650; so they can easily afford to pay you $136 for your money and are happy to spend a lot on television and newspaper ads to lure you into their shops.

(Incidentally, should similar battles flare up among the banks where you live, you might want to keep in mind that you can be an alchemist, too – assuming you are in the 50 per cent bracket and have some security to offer. It’s easy: You borrow $100,000 from Bank A, paying perhaps 15 per cent interest. You use this money to buy a $100,000 CD from Bank B that will earn $13,600. Since your tax will be reduced by $7,500 because of interest paid, you will have a profit of $6,100. After taxes you will be left with $3,050 net-all for simply signing your name a few times, and having a lot of money to begin with. And if you run part of this through your IRA, your gain will be greater.)

Can the banks continue doing that forever? Well, it isn’t quite like a chain letter, but it can be kept up as long as there are people and businesses clamoring to borrow money. (The private dodge I have outlined for you can be pursued as long as Congress allows a deduction for interest paid.) Should the demand for loans collapse, or should the loans turn “nonperforming,” the party would be over. For this reason, one may presume that a modest shuffling of the feet is also going on behind the scenes as the banks get ready to raise the prime rate again, probably not until after the election.

And why not? It’s as plain as day that their little CD wars will result in a higher cost of funds for all of them. Finally, a playlet is being prepared behind the scenes that will go like this:

Enter Stern Bank Examiner, who says (sternly): “Hey, you’ve got to stop making those crazy loans to Third World countries and oil wildcatters and speculators in California real estate. Even though the United States has figured out how to have what we say is a recovery with eight or 10 million unemployed, the rest of the world is still depressed, and the demand for oil is going down, and there really is a limit to what anyone in his right mind will pay for a piece of the San Andreas Fault.”

To that, Deregulated Big Banker will reply (contritely): “Well, shucks, sir. Then this bank, which I remind you is bigger than you can possibly imagine, will have to go bankrupt, because our cost of funds is so high that we have to make these crazy loans at high rates, or we can’t pay our bills. If you say we have to go bankrupt, why of course, we’ll do as you say. But if we go, I humbly remind you, we’re so big that we’ll pull a whole lot – maybe everything-down with us, and we wouldn’t like to do that. ”

Whereupon Stern Bank Examiner will answer (sternly): “Well, all right. If you can’t be good, be careful.”

The consequences of such unavoidably permissive regulation will extend far beyond the cost of bailing out a superbank every now and then. Most immediately, the rest of the banking system will be strangulated. If the biggest banks are essentially free of regulation, the remaining banks (some of them bigger than I can imagine) will be at a competitive disadvantage unless they can sell out to a super bank or combine with others similarly situated and become superbanks themselves. The merger movement, already possessed of enough momentum to satisfy a sports announcer (including one formerly known as Dutch[1]), will proceed apace. Everybody will become too big to be allowed to fail.

That last sentence is twice as long as it should be. If we are truly to learn the lesson of Continental Illinois and Financial Corporation of America and Lockheed and Chrysler, the sentence should read, “Everybody will be too big.” Period. Put another way, the lesson we should learn is that great size, in and of itself, is an economic evil. For almost a century, since the passage of the Sherman Antitrust Act in 1890, we have said and repeated and contrived to believe that the issue is competition, not size. The Sherman Act has been amended and strengthened, most notably by the Clayton Antitrust Act of 1914 and the Robinson-Patman Act of 1936; the courts have been clogged with cases, some of which dragged on for decades without a decision; and always the effort has been to discover and enforce a judicial definition of competition.

The effort has not succeeded. The power of the “trusts” of 1890 was insignificant in comparison with that of the Fortune 500 or the Forbes 500 of today. Absurdities have multiplied. It is, for example, established antitrust law that a company can engage in what the law defines as unfair business practices when the company has to do so to meet competition. If you think that’s nutty, you’re right.

I’m not saying that we would be better off without Robinson-Patman and the rest. I’m merely saying that the expensive, time-consuming antitrust effort has failed to come close to its promise, and that its failure follows from the apotheosis of competition.

In this space a couple of months ago (“Unthinkable Thoughts on Competition,” NL, April 2), I presented some empirical evidence that competition doesn’t always work for the benefit of the consumer. For evidence that it doesn’t always work for the benefit of the producer or of society, I refer you to a 1921 essay entitled “The Ethics of Competition” by the late Professor Frank H. Knight of the University of Chicago. Knight demonstrates in careful detail what we know in our hearts, namely that the competitive race is seldom fair, and that the effort it stimulates is as likely to result in chicanery as in beneficial innovation. One of Knight’s favorite pupils was Milton Friedman, showing that, happily for mankind, personal relations are thicker than ideology.

If competition doesn’t work, what does? Not cooperation. That is merely the flip side of the coin. Milovan Djilas and a great many others are ready to tell you in convincing detail that cooperative societies, with the best will in the world, tend to degenerate into stultifying dictatorships. I propose that we look a bit more closely at the question of size.

SINCE THERE ARE unquestionably economies of scale, it would seem that we are stymied in that direction, too. As a matter of practical politics, we are undoubtedly stymied now and will be for a long time. But there does exist a workable solution. It is embodied in a 166-page book published in 1947. The title is The Limitist, and the author is Fred I. Raymond.

Raymond was a successful executive in a family business that was sold, against his advice, to Wall Street speculators. Then he was an inventor of successful heart-regulating devices that he had to sell to Minneapolis-Honeywell because he couldn’t get at the market for them. Then he pondered what had happened to him and wrote his book, which I am very proud to have published. It attracted attention from John Chamberlain of the Wall Street Journal on the Right and Senator Paul Douglas of Illinois on the Left, but of course was (and unfortunately still is) long before its time.

Observing the courts’ inability to define competition, Raymond put forward what he called a limitist law. The speed limit is such a law. If you go over 55 miles an hour you are in violation, no matter what arguments you can make about safety or efficiency or the behavior of others. Observing the way business works, Raymond concluded that seeming economies of scale are often (if not generally) results of the favored access great size can command to finance and to markets. The Chevrolet plant in Tarrytown, New York, for instance, achieves (or could achieve) all the engineering economies of scale available in automobile manufacturing. It is not made more efficient by the existence of similar Chevrolet plants elsewhere.

On the basis of these observations, Raymond proposed that a business organization could be as large and as spread out as it wanted to be, provided that it had only one place of shipment to its customers, whether other manufacturers, retailers or the public. If a business had more than one point of delivery, it would be limited to a certain number of employees. Raymond suggested 1,000 as the maximum. He drafted a “Business Limitation Act” that runs to not quite 2,000 words, including definitions of terms.

I doubt that you have heard of a more elegant, simple, effective, and far-reaching proposal. The book never sold many copies and has long been out of print, but I suppose you can find one in some library. If you do, you will be well repaid for the two or three hours it takes you to read it. It is, as Chamberlain said, “a practical way of dealing with the economic ‘sin’ of bigness that doesn’t require cumbersome bureaucratic supervision, insidious taxation of human energy, or incessant effort to prevent government corruption.”

We can, of course, simply give up and turn the country over to the Business Roundtable. Or we can keep muddling through the courts. Or we can make a start at diagnosing and treating our actual ailment. That is, we can face up to the problem of bigness.

The sad fact is that we had a limitist law in banking in the shape of Regulation Q, which limited the interest certain banks could pay. It was not altogether effective because it could not (given the patchwork control of our financial system) cover all it should have covered. In the circumstances it would have been rational to extend the coverage. But overawed by the wealth and wisdom of Walter Wriston and his ilk, we reduced it, instead. The more fools we.

The New Leader


[1] Reagan

Originally published October 17, 1983

CONSTANT readers of this column have foreseen since THE NEW LEADER issue of March 8, 1982, what last month burst like a paper bag full of cold water over the heads of the self-assured enthusiasts for Reaganomics. The New York Times, evidently relying on Federal Reserve Board figures, announced that our national rate of saving has steadily declined in spite of the massive supply-side tax cuts that were supposed to stimulate it.

This development has caused some bewilderment. Norman B. Ture, former undersecretary of the Treasury for tax and economic affairs, who was the “architect” of the 1981 tax cut, said the news was disturbing and surprising. “It’s very difficult to understand,” he added. Other worthies were tempted to dispute the figures, for the mind-boggling reason that “they cannot show tax-evasion income” (the inference being, I suppose, that the so-called recovery has been fueled by illegal savings).

As you know, I am like Adam Smith in that I hold no brief for statistics. (One of the most successful books I ever edited was entitled How to Lie with Statistics.) It does, nevertheless, seem to me fitting that those who live by statistics should die by statistics. In the present instance, I think it as likely that the rate of saving has been overstated as the other way around; but whatever the precise figures may be, they certainly show that the tax cuts didn’t do what President Reagan promised they would do.

Nineteen months ago I told you why they wouldn’t. I wrote that unless the government is running a surplus, there is no way for tax cuts to be a direct stimulus to productive investment.“ To emphasize the point, I said it in italics, a typographical device I don’t resort to lightly.

My reasoning was as follows: “Try as he will, the supply-sider can’t get money into the hands of producers. This is not because of the conspicuous consumption of the rich or the notorious perversity of Wall Street. Even when everyone is doing his best to cooperate, the scheme can’t work. The supply-sider’s tax cuts go to the rich, all right; but the recipients have to lend the money right back to the government to cover the [increased] deficits. No more money becomes available for productive investment than there was before the game started.” I continued: “You will note that I say ‘available,’ because I don’t for a minute believe that much of that tax windfall would go into productive investment even if it could. Almost all of it is earmarked for speculation. No goods will be produced as a result of it, nor any services rendered. But the rich will be richer.”

Two months after my column appeared, the Times had a roundup of opinion on the economy, in which Professor Arthur Laffer was quoted. He was a big man in those days, with a curve named after him. The Laffer Curve, you will remember, was the principal intellectual underpinning of the Reaganomic tax cuts. Though it first appeared on a cocktail napkin and never was able to find empirical support, it was used to justify giving major tax cuts to the rich (whose incentive would otherwise be sapped). But on May 2, 1982, Laffer was quoted to the effect that the cuts would have “no economic effect” because the government would “give a dollar back and then borrow it right away from you.”

Yes, that is what I had said, and it amuses me to think Laffer might have gotten the idea from my column. That would have been sufficiently astounding. Sensationally astounding was the fact that here was one of the original supply-side gurus confessing that the scheme wouldn’t work. Laffer’s recantation was on a par with David Stockman’s confession that Reaganomics was a Trojan Horse for the rich.

Unfortunately, the Times business reporters are so used to stitching stories together out of mindless handouts, and Times readers are so used to skipping such stories that not even the Times editors noticed the recantation. In an editorial some weeks ago they still didn’t understand what had happened, attributing the fall in savings to the failure of the tax cuts to give individuals any “particular incentive” to save.

Now, in discussions like this, one can easily lose track of what the real issue is. The real issue here is not why savings have fallen but whether it makes any difference, and whether any “particular incentive” should be legislated to change the situation.

Classical economics noted that steam driven looms produced more cloth than hand looms, and were bought by men who had saved some money or could borrow the savings of others. Thus it seemed obvious that savings increased production (and so were virtuous and should be rewarded). That analysis, however, was inside out, as any moderately reflective businessman has known these past two centuries. For regardless of the savings one has accumulated, one is not well advised to buy a power loom if there is no effective demand for cloth or if the demand is already oversupplied. Of course, if there are no investment possibilities in textiles, there may be some elsewhere. But when you have 12 per cent of your labor force and 30 per cent of your industrial plant standing idle, the odds are against finding suitable places to put your savings, no matter how much you have laid by.

In this situation – which is the situation we have been in and are still in –  you can do two things with your savings: you can live it up, or you can speculate. Speculation, I’m ready to admit, is my King Charles’ head; I will therefore confine my remarks on the point to asking where you think all the billions came from that have gone into the stock market in the past 15 months.

Putting speculation aside, let’s look at living it up, otherwise known as consumption or demand. Here again, classical economics has something to say that seems plausible enough until you stop to think about it. The gimmick is Say’s Law. Jean Baptiste Say, a French contemporary of Adam Smith’s, had it figured out that production creates its own demand. He reasoned this way: If you set up a textile mill, you have to pay the people who build the factory and those who make the looms and those who raise and shear the sheep and those who run your looms. All these payments are used by these people to buy things they want or need, and the people who sell them these things use the money they are paid to buy what they want or need, and so on and on. Sooner or later, someone will buy your cloth. Or if no one does, it still happens that a lot of other goods are sold, so that, in the aggregate, production creates demand, and a universal glut is impossible.

MALTHUS, among a handful of others, saw that this is nonsense (because of the time lapses involved, if for no other reason), but he couldn’t convince his friend Ricardo or the followers of Ricardo. It took the Great Depression, when an unsalable glut existed for all to see, to exorcise the ghost of Say. And yet, only a half century later, the ghost of Say is again seen nightly on the battlements and occasionally stalking abroad in full daylight, driving Atari Democrats and self-advertised liberal businessmen mad with schemes to reduce consumption in the hope of increasing production.

A convenient example is at hand in an Op Ed page piece in the very issue of the Times that carried the story about the fall in savings. The author is one Fletcher Byrom, chairman of the Committee for Economic Development, described as “an organization of chief executive officers and university presidents.” Awesome. Byrom proclaims: “The United States needs to move away from a patchwork tax system that penalizes saving and investment toward one with more systematic emphasis on taxing consumption.” Someone should take Byrom aside and tell him about the Economic Recovery Tax Act of 1981.

He might also glance at another story in the same issue of the Times revealing that millionaires have multiplied like fruit flies even as savings have been languishing. There were about 180,000 millionaires in 1976 and 500,000 in 1981. It is not irrelevant that the great leap forward coincides with the introduction of the maxi tax on “earned” income. Goodness knows how many millionaires there are today, but I’ll bet the number has redoubled since the maxitax on unearned income went into effect two years ago. (I’ll bet the number of those below the poverty level has redoubled, too.)

If Byrom and his committee have their way, there will be still more people with millions to throw around. Their fortune-good for them but bad for the country – will be made possible by lowering the personal income tax and the corporation tax, while raising Social Security taxes and sales taxes, and maybe introducing a value-added tax, which is a semi-hidden kind of sales tax.

I am sorry, but I find it difficult to have proper respect for chief executive officers and college presidents who talk this way. The empirical evidence is plain that their policies have not done what they promised, yet they persist in them. The empirical evidence is plain as well that their policies have caused appalling suffering, not only in this country but throughout the world. Nonetheless, they persist. Although I find it hard to have proper respect for these people, I’m scared that they will continue to have their way.

The New Leader

Originally published April 19, 1982

Dear Editor

Speculation

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.”

Originally published September 7, 1981

Thinking Aloud

WHY
SPECULATION
WILL UNDO
REAGANOMICS

IF YOU’VE GOT some money and want to use it to get more, there are three quite different things you can do: You can gamble, you can speculate, or you can invest. Since all three are ways of getting rich – or of going broke – your choice may not make much difference to you. But it will make an enormous difference to the economy, especially in a period of inflation. Perhaps because the choice is immaterial to the person with money, the effect on the economy is not generally noticed, with devastating consequences.

Speculation – what we’re mostly going to be concerned about here – has long had a bad name with the man in the street. Speculators, whether in Continental scrip or Civil War greenbacks, in city lots or rolling farm land, in domestic silver or imported coffee, have traditionally excited the envy or the hatred of their fellow citizens. In everyday speech speculation falls somewhere between gambling and investing; its connotations are disapproving. Although not quite so reprehensible as gambling, it is still suggestive of something secured for nothing, generally at an undue or unsafe or unsound or even unsocial risk. Brokers warn against speculative stocks, and the courts consider it imprudent to risk widows’ and orphans’ pittances on such issues. A successful speculator is a standing reproach to anyone who works for a living.

Most academics, however, disapprove of disapproving holding it to be unscientific, and possibly for this reason you can read many standard introductions to economics without ever encountering the word “speculation.” Hard-headed bankers and publicists ‘and – more to the point – hard-headed lawmakers tend to follow ‘the textbooks’ lead and ignore the activity. This neglect has helped to skew the economy and, in the present state of the world to frustrate many well intentioned measures to control inflation. For speculation is real enough, and there is reason to believe it is as much a cause as a result of inflation. To see why, we must distinguish among the three roads to riches. Our distinctions are not idle; they are of the utmost importance for the understanding and management of the economy-and, I am sorry to say, they are original.

Gambling is risking wealth in a zero-sum game. In any gamble-betting on cards or horses or football games- if some players win, some other players must lose the same amount. The winnings and the losings (after properly allocating taxes and the house’s cut) add up to zero. Nothing has been accomplished.

Speculation differs significantly from gambling in that it is not a zero-sum game. Speculation is risking wealth in an activity where all the players can win, or all can lose, or some can win and some can lose. It involves the buying and selling of stocks and other claims to wealth, the attempt to profit from or hedge against the vagaries of the market, the merging and spinning off of businesses, occasionally the churning of exchanges, the hoarding and dumping of almost anything imaginable. It creates no wealth but rearranges – sometimes to the very great profit of the re-arranger – wealth that already exists. It has been argued that, in the aggregate and over time, what goes up must come down and therefore speculation is a zero-sum game, too. But the speculative run is parallel, if not identical, with the inflationary run. If speculation were an irrelevant zero-sum game, inflation would likewise be nothing to fuss about: the two would rise and fall (assuming they do) together.

Investing is akin to speculation in that it is not a zero-sum game. In a healthy economy it is possible for all reasonably astute producers to profit, at least to-a degree, and contrary to current thinking this is true whether or not resources are limited. Investing differs from speculating in that it uses wealth to create new wealth. Its aim is the production and distribution of goods and services. These may be new kinds of goods and services, or they may be more of the same; they may be produced in new ways or in the good old ways; they may be provided by new businesses or by expansions of existing businesses; they may be what your heart desires or what you scorn as shoddy. The point is, economically they are goods.

Gambling, speculating and investing are frequently distinguished, notably by laymen and lawyers, on the basis of risk. Yet all three are risky. (To paraphrase President Kennedy, life is risky.) Nor is there any correlation between risk and economic effect. In gambling, the odds are often known with mathematical precision; that is ‘what makes casino owners rich. In speculating, one can command the services of brokers and advisers who spin out their lives poring over charts and tables. Investing, On the other hand, can be very risky indeed; despite meticulous market research, a highly promising new product may turn out to be an Edsel.

Economists, being locked into their equilibrium models; generally confuse the issues in another way. Gambling, it is obvious to them, has no impact on the economy, except to the problematic extent that it distracts people from more productive endeavors. What one wins, another loses, and the GNP remains as before. I n a world enjoying relative equilibrium, speculation seems no different. Commenting on John Maynard Keynes‘ ultimate disapproval of speculation (after he had made a small fortune buying and selling foreign currencies), Roy Harrod gives us the classical view: “As regards the gains of the successful speculator, in the case of foreign exchanges, this was solely at the expense of the unsuccessful, who, since he has voluntarily incurred the risk, had no legitimate hardship if the risk went wrong. In the case of commodities, the same argument largely applied: what speculator A gained, speculator B lost….”

That is a fair enough description of what happens-provided the-economy is in equilibrium. But suppose the economy is not in equilibrium, or even close to it. Suppose, indeed, that inflation is, as they say, raging: 4 per cent a year, 5, 8, double-digit, 12 per cent-with no end in sight. What does speculation look like now? Most important for our purposes, it no longer looks even vaguely like a zero-sum game. With a little bit of luck almost any of the speculators can win. There need be no losers among those who play the game. Some may, to be sure, gain more than others. I may sell my pot of gold just before it makes a great leap forward, but even the more sluggish hog-belly futures that I then buy are also on their way up.

IN SUCH a situation only the timid or foolish (or impoverished) will forgo the fun. The brash and clever and rich will, moreover, recognize that in inflationary times the thing to do is speculate: in common stocks of companies that (like Conoco) have substantial holdings of natural resources, in commodities, condominiums, works of art, objets d’art, collectibles. Almost anything can be a collectible. One of G. Gordon Liddy’s regrets was that he felt obliged to shred his match-folder collection lest it reveal to the Watergate investigators the many motels he had stayed at as he careened down the sub rosa way.

Keynes devoted 10 pages of The General Theory of Employment, Interest and Money to an attempt at differentiating between short-term speculation (which he saw as the pervading vice of Wall Street) and long-term “investment” by a “professional” who makes a point of understanding the businesses whose securities he buys and “who most promotes the public interest.” Yet except as one has a pseudo-esthetic preference for steadiness over flashiness, it is hard to see the differentiation. Even Keynes acknowledges that the lucky or clever speculator may make larger sums than his more careful cousin. And it does not matter to the companies whose securities are traded. After the first sale to the public, the buying and selling of their shares does them no good, and ordinarily no harm, either. Surely they don’t care how intelligent or stupid the buyers and sellers may be.

Corporation executives do of course take an intense interest in the vicissitudes of their companies’ stocks. Partly this is because they may own some, or have options that are worth more as the stock goes up; partly it is because their present salaries, and prospective salaries elsewhere, are dependent upon their success in making money for the speculative investors who play the market. In certain instances their companies may want to attract additional funds for some purpose or other-even including the expansion of production, although this is not very likely in inflationary times.

One of today’s common misapprehensions is that the securities and commodities exchanges are engaged in supplying capital to those who produce goods and offer services. No doubt the exchanges once did actually encourage the investment of funds that might otherwise have lain hidden in mattresses because of their owners’ liquidity preference. But that day is long past. The value of all new stock issues (many – if not most- of which had only speculative ends in view) on all exchanges in all of last year, was about the same as one week’s trading on the New York Stock Exchange alone.

 It is safe to say that considerably less than 1 per cent of the transactions on the financial and commodities exchanges have anything whatever to do with productive investments. The rest are speculations. No producer gains the use of capital from them. Though the traders-may become rich, no new wealth is created by their frenzied activity. Yet because it became public policy (Icing before supply-side economics was thought of) to encourage investment, so-called long-term capital gains are taxed at a very favorable rate-just cut to

20 per cent. Given the tiny fraction of exchange transactions actually supporting production, it is plain that the favorable treatment almost exclusively stimulates speculation.

And speculation sucks money into itself like a firestorm. It always can use more. Vast sums are needed merely to keep transactions afloat for the few days it takes the brokers’ back rooms to complete them. These sums swell with speculation. In the first six months of this year, the New York Stock Exchange set a new record of 6.1 billion shares traded, thus requiring upwards of 10 times as much money to conduct its business as it did only a few years ago. Meanwhile, everything from a collection of beer cans to an example of Picasso’s blue period has been soaring in price as much as 100 percent a year, and the amount of money this ties up obviously has been increasing correspondingly

No productive enterprise can make money that fast. The after-tax earnings on equity of the Fortune 500 business runs around 10-15 percent, even in good years. Now that the interest rates they have to pay (or earn internally are well into the double-digit range, their record is poorer. (That’s why this inflation hasn’t sent the stock market through the roof, as everyone expected.) Smaller businesses – the kinds that arouse the same sentiments as mom’s apple pie – are on the whole having a much harder time. A man is a fool to work to produce something in the hope of earning 10-15 per cent when he can make many times that simply collecting Dresden china (should his fancy rake that turn).

The speculator, on the other hand, is perfectly happy borrowing every dollar he can lay his hands on at 15-20 per cent or more if he can thereby turn a profit of 20-30 percent. Aside from his apparent gain, he gets an enormous bonus from the income tax laws. The interest he pays on the money he borrows is deductible at the same rate as ordinary income, while his profits are taxed at the very much lower capital gains rate. Leverage like that can be very attractive.

Similar considerations underlie the activities of conglomerating corporations. In fact, they levy a greater toll on the money supply than all the individual speculators combined. DuPont is borrowing $4 billion to consummate its CONOCO deal (a speculation in coal more than in oil, but certainly not in enterprise). Bankers argue that Conoco’s happy stockholders will recirculate their windfall by making new” investments.” Yet whether they take out their profits in riotous living or use them to bid up other speculations, the economic effect will be inflationary.

Twelve other giant corporations – mostly oil companies with conglomeration in mind – have secured lines of credit totaling $42 billion. This may be the iceberg. or only its tip, for scores of smaller (but still large) corporations have un totaled lines of credit to finance takeovers, Whatever they add up to, they represent money withdrawn from the economy at least until taken down, and in any case not available for productive investment. There is seldom the slightest pretense that conglomeration will increase production; the goal is the fast buck, and many billions of dollars are being devoted to pursuing it.

The situation has been aggravated by the policy of the Federal Reserve Board under former chairman Arthur F. Burns and his successor, Paul Volcker, The Fed’s attempt to hold down inflation by controlling the money supply has further encouraged speculation at the expense of productive investment. With speculators and conglomerators snapping up the limited funds available irrespective of interest rates, producers cannot afford the financing they would invest in new products or services, or new ways of providing old ones. This is how the recently discovered productivity gap came about, and the easing of the capital gains tax will widen it for having enhanced the appeal of speculation.

Productive enterprise has been so systematically starved during the Burns- Volcker years that-especially with the addition of millions of women and blacks to the labor force-a great influx of money probably will be required to get the economy working again. This is, indeed, an insight that supply-siders share with fiscalists. But so long as nothing is done to curb speculation, the new money, whether from the Fed or from lower taxes, will flow into speculation or consumption and leave production as hungry as before.

THE THING about speculation, of course, is that sooner or later the kissing stops; and almost everyone gets caught with a long position in tulip bulb futures. The South Sea Bubble bursts; Wall Street lays an egg. When the bubble bursts, speculation feeds on itself going down, as it had fed on itself going up. Going up, everyone can win; going down, everyone can lose. Successful bears are very few, and their contribution to the common wealth is to make the disaster worse faster.

Is a disastrous outcome inevitable? In the light of the nostrums the Reagan Administration has had enacted into law, some sort of disaster can be predicted with confidence (if that is the right word). Because of the FDIC (horrors! – Federal regulation), there will be no run on the banks this time, and that will be a blessed distinction from the Great Depression. Because of the SEC (another regulative agency!), Wall Street pools are a thing of the past, and it’s harder to make a killing there (so fewer will be killed).

But the expectations of the innocent supply-siders will surely be dashed on the rock of speculation: The proceeds of the tax cuts will not go into productive investment; the money· supply will continue to resist management; interest rates will not fall; the surge of inflation wiII not abate this side of recession. If there are cynical supply-siders, and I rather think there may be some, they will be pleased with what they see:· The rich will be richer (at least comparatively), the big will be bigger, and the nation’s markets will be more firmly controlled by the kind of leaders who have made such recent successes of the automotive and steel industries. Amid all this, cruel unemployment will steadily spread.

The disease was first named by the British, who called it “stagflation.” A moderately reflective person might have expected that the experience of Great Britain (which doesn’t have the excuse of OPEC) would give pause to the noisy enthusiasts for low capital gains taxes and high interest rates. The British have been playing the game longer than we have-and their stagflation is worse than ours. But it seems (hat we are doomed to repeat their game plan.

It is a crying shame. The grief that will be caused is incalculable. And speculation could be easily inhibited. The Federal Reserve Board could forbid the granting of loans for purposes of trading on any securities or commodities exchange, or for purposes of merging or acquiring businesses, The Fed already sets limits to brokers’ margin accounts; at various times in the past it has forbidden them altogether; it could do so again tomorrow morning. Congress could readily tax capital gains as. ordinary income (owner-occupied dwellings might be treated differently, although I can imagine strong arguments against this). At the minimum Congress could, without being reproached for irrationality, define a long-term” capital gain as one on property held for IO years instead of one. Even five years (recognized by the money markets as the definition of “long-term” financing) would be a great step forward, particularly if coupled with modifications of the charitable deduction and elimination of other inflationary tax shelters.

The Fed and the Congress don’t do these things because they think the sole difference between speculation and productive investment is that the former involves more risk than the latter. But the true difference is, to repeat, that speculation has only financial gain in view, while productive investment uses wealth to produce more wealth. Though the risks may be great, investment can stimulate the production of goods and services. Regardless of risk, speculation can only stimulate inflation. Production improves the common wealth and the standard of living of the citizens; speculation simply redistributes what is otherwise created, and deflation destroys it.

It should be remarked that my proposals to deter speculation do not take sides – and do not need to take sides – in the fiscalist vs. monetarist controversy. There is very likely much truth on both sides, but there is assuredly no help possible from either side if speculation is not discouraged. While I am not a gambling man myself, I do not think there will be no more cakes and ale. It is not proposed to outlaw gambling or speculation. It is merely proposed that our government stop encouraging speculation. The Fed’s doctrinaire (false doctrine) refusal to consider the uses to which our money is put encourages speculation. The Congress’ espousal of a low capital gains tax encourages speculation. The new gift and inheritance tax encourages speculation. It would be easy enough for us to cease and desist from these encouragements.

As matters stand, one may read the Wall Street Journal or the financial pages of tile New York Times or any other metropolitan newspaper day after day and find very little news on some days none at all – concerning people producing something to sell to other people to satisfy their needs or wants. The shocking fact is that a great number of the best and best educated brains in the country are caught up in speculation of one kind or another, in devising new speculative schemes and new tax shelters. Our laws foster a sad misuse of this potential national resource. Getting and spending we lay waste our powers. President Coolidge was wrong: The business of America in the 1920’s was not business; it was speculation. It is speculation again today,

Finally, it may be objected that the proposed discouragement of speculation will not, of itself, control inflation. Certainly not. But unless speculation is deterred, inflation cannot possibly be controlled. Unless one is ready to run the printing presses flat out, the only way to get money into productive hands is to see that little or none of it falls into speculative hands. The first step toward achieving this is understanding what speculation is. Speculation is not risky productive investment. Nor-emphatically-is it economically neutral, like gambling. Far from it: Speculation is coterminous with inflation-and, as we are in grave danger of soon rediscovering, coterminous with deflation, too.

The New Leader

%d bloggers like this: