Monday, September 13, 2010

Karl Denninger Drinks the Kool-Aid Without Knowing It

Karl normally is highly skeptical of government statistics.  Unless said government statistics confirm what he already believes, in which case he gives them a big sloppy kiss.

Karl's posts today of both phenomenon.  For example, here he takes "Turbo Timmy" Geithner to task for fudging numbers, and here he gobbles up rigged government statistics and finds them so tasty that he regurgitates them to experience the flavor once more.

Specifically, in arguing that that the Bush tax cuts for the wealthy, Karl argues:

Because capital formation comes from savings.

Capital formation is what creates jobs. It is what fuels small business. It is what causes people to be hired, which increases economic activity.

In order to have capital formation you must have saving.

If you borrow instead then you're stuck paying debt to a bank, and worse, you're diluted in your effectiveness severely compared to someone who saves, as you must pay interest while he does not.

When the first Bush tax cuts were signed into law in June 2001, pushing the top rate down to 35 percent, the wealthy boosted savings. The saving rate climbed to 2.8 percent in the first quarter of 2002 from minus 2 percent in the second quarter of 2001. The increased savings coincided with a 1.1 percent decline in the S&P 500 index.
Yes, and what followed was a burst of entrepreneurship, which is how we create jobs!
First of all, as documented previously on this site, real personal disposable income (DPI without imputations) was negative from 1998 - 2007.  Since the personal savings rate equals savings divided by disposable personal income, by implication the real savings rate was negative for that period was likewise negative, which this chart confirms:

(click for larger image)

Okay, how about that "burst of entrepeneurship?"  Did it really create jobs?  Let's take a look at the unemployment statistics around that time:

(click for larger image)

Hmmmm.  It looks like unemployment actually went up for a couple of years before new jobs were found.  Of course, we know from John Williams at Shadow Government Statistics that the BLS can artificially depresses the unemployment number by not counting everybody.  So let's take a look at the civilian participation rate:

(click for larger image)

Hmmmmm.  This shows that the percentage of employed Americans started declining in 2001 and did not start increasing until 2005 without ever making it back to the rate at which it stood when the Bush tax cuts were passed.

Sorry, but the facts don't support Karl's assertions, which are likely based, in part, on Keynes' (gasp!) conclusion that Savings equals Investment.  The problem is that when "investment" is actually speculation (as when you "invest" in the secondary equity market by buying existing shares of a company), savings does not lead to capital formation or jobs.

So what did the wealthiest Americans do with the money from the Bush tax cuts, if they didn't invest it and create jobs?  I'll tell you what I did: I used it to speculate on the stock market. 

The fact is that increasing the free cash flow of the wealthiest Americans increases their appetite for financial speculation, and with so many people and so much money seeking yield, the risks get multiplied and lead to financial instability, then financial crises and, ultimately, depressions like we're in right now.

I'm not saying that increasing nominal tax rates of the wealthiest Americans is necessarily the solution.  Indeed, I think it among the least efficient ways to grow the American economy (you don't necessarily add to real economic growth by subtracting from the funds the wealthy use to bet at the casino).  I'm just saying that increasing the wealthiest Americans' free cash flow does not necessarily have any stimulative effect on the American economy because the use it for financial speculation, not for creating new businesses.