April 13, 2010

The Obama Bubble

By William T. Alpert

Why is there a remarkable stock market rally in the midst of the worst recession (depression) since 1930? While we hear explanations of every day's rise and fall of the indices (e.g., the "whatever" numbers were not as bad as expected, or they were better than anticipated), the obvious answer is that a few serious investors have studied their (arcane) National Income and Product Accounting.

The stock market is rising because extraordinarily high corporate profits are just around the corner. The late Michal Kalecki, an obscure Polish economist, formulated the explanation in the early 1930s, summarized in his Selected Essays on the Dynamics of the Capitalist Economy, 1933 to 1970 (Cambridge University Press, 1971). Kalecki's views were echoed much more vociferously by the late disciple of Joseph Schumpeter, Hyman P. Minsky, and a pioneer in modern business cycle theory who expounded the national income identity that corporate after-tax profits are equal to private investment plus the government deficit plus the trade surplus plus consumption from profit income less savings from wage income (the latter two terms are relatively minor today). (See Minsky's The Business Cycle and Public Policy, 1929 - 1980, Joint Economic Committee, Congress of the United States (GPO, 1980.)

This equation applies only during the short term -- which is what the textbook debate about Keynesian and the New Classical Economics is all about. But since no one except Keynes himself, Joan Robinson, Kalecki, and Minsky really understood Keynes (all with different understandings), and since none of these economists believed, as do modern interpreters of Keynes, that he (or Kalecki) was drawing an exact timeline for the long and short term -- we still must ask, How long is the short term?

In spite of protestations to the contrary, no one knows the timing lags associated with any of these policies. But suppose that the short term is twelve months, more or less. Since H1N1 flu is not likely to kill all of us off in the next year, Keynes's "in the long run, we're all dead" comment does not apply. This means, as pointed out by Kalecki and Minsky, that corporate profits are defined as equal to investment plus the deficit less the trade surplus (and the other likely minor items). In the next twelve months, profits will be huge! The market, which has a quarter-to-quarter time horizon (and at least we will all agree that this time period is short term), recognizes this, and also the fact that the government deficit (not to mention state government deficits) are immediately discounted into projected profits, which will increase the price of equities in the short term. Perhaps the deficits don't really matter (but of course, they do) because of their deleterious effects on growth over the long run. Unless by some providential intervention the government's financial bets pay off and the economy soon is truly in recovery, this market is provided courtesy of debt like none other in history! A true economic recovery is highly unlikely any time soon, given the global nature of the meltdown and the porcine composition of the "stimulus package"!

When the markets come face-to-face with the inevitable end of huge deficits, the bubble -- the Obama bubble -- will burst, and the markets will crash again. This, of course, is a decision for political economy and is the topic for another essay.

While we do not know the exact magnitudes of these statistics at this moment, we do know that gross investment historically is about $2 billion per year and the trade surplus is currently minus $26 billion per month, and the federal deficit is projected to be on the order of $1.6 trillion this year, with deficits well over $1 trillion last year and next. This will put corporate profits at something on the order of $1.5 trillion. Corporate profits have averaged $1.2 trillion during the last five years, according to the Treasury Department. Thus, even if real corporate profits (independent of the deficit) were zero or negative this year (an unlikely prospect, given the unprecedented expansionary monetary policy during the possibly ended recent recession) profits would be recorded as historically high.

This implies that accounting profits for the economy as a whole are projected to be on the order of $300 billion per year higher than they have been during the boom. Does anyone hear a "pop?"