Financial Profits Reduce Economic Prosperity

June 28th, 2011
in Op Ed

steelworkers Guest Author: Lance Roberts, This was first posted at Advisor Perspectives

The updated corporate profit data in Friday's GDP release reminded me of the demise of America at the expense of Wall Street.

America was once a country built on the solid foundation of the hard work, satisfaction and pride in the building of stuff. We aren't talking about "namby pamby" stuff; we're talking about real stuff. We used to produce everything from automobiles to steel to blue jeans — right here in America. We ran telephone lines, built roadways and bridges, drilled for oil and constructed buildings. It was the sweat of the brow and the strain on the back that built America into its former shining self. We were a country of opportunity and prosperity with a solid moral foundation and a strong military to back it up.

Follow up:

That was then.  Beginning in 1980, our world changed as we discovered the world of financial engineering, easy money and the wealth creation ability of leverage. However, what we didn't realize, and are slowly coming to grips with today, is that financial engineering had a very negative side effect: It deteriorated our economic prosperity. As the use of leverage crept through the system, it slowly chipped away at the savings and productive investment. Without savings, consumers can't consume, producers can't produce and the economy grinds to a halt as the cycle of economic growth is thrown into a "balance sheet recession" strangle-hold that is slowly pushing the economy towards unconsciousness.

Yet, even with the economy hobbled and struggling, the average American functioning as if we are still in a recession, the main focus of the current Administration continues to be the bailout of the very companies that not only got us into this mess to start with but are the very leeches on economic prosperity that we need to be ridding ourselves of.

As the chart above illustrates, financial profits as a percentage of total profits have risen over the past thirty years, while the year-over-year change in our Gross Domestic Product has slowly deteriorated. This is due to the "multiplier" effect of dollars spent. If I manufacture or build something, there is a large multiplication effect of each dollar spent as it flows through the economy, creating ripples of aggregate demand in its path. However, as money is shifted from these low margin businesses, which have a high multiplier effect, to high margin, low multiplier, devices and schemes on Wall Street such as securitization products and "Ponzi schemes". This shift of focus from manufacturing type "blue collar" jobs to high finance "white collar" masters of the universe has created the largest gap in the history of the United States between the "Have's" and the "Have-Not's".

Not all financial services and businesses are bad. However, an excess of anything is harmful to the system into which it is introduced. Much has been written since the financial crisis about the systemic risk that major Wall Street firms impose on the economy, and the data tells the rest of the story. We have done nothing to solve or resolve that which brought this country to its knees in the first place. We have bailed out the culprits, turned a blind eye to the facts and now leave the rest to hope and prayer that somehow things will turn out okay as the average American is slowly bled to death.

This is why we need real reform in government that leads to a smaller government, more clarity for businesses through pro-growth policies, real regulation of Wall Street that separates banks and brokerages, as well as programs and subsidies for bringing back to America those jobs that require a little hard work, a little bit of sweat and create a whole lot of pride and prosperity along the way.

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1 comment

  1. Derryl Hermanutz Email says :

    From the classical economists like Adam Smith and J.S. Mill to Kumhoff and Ranciere today, I think it is well established that financial rents are parasitical and destructive to an economy as Lance Roberts observes. Reigning in finance and restoring a "real" American productive economy are certainly essential planks in any American reformation platform. But how?

    Former CIBC chief economist Jeff Rubin, now author of the peak oil book, "Why your World is about to get a Whole Lot Smaller", believes that as the transportation component of import prices rises with the inevitable rise of fuel costs, US manufacturing will enjoy a renaissance on economic grounds. No "subsidies" or other political aids would be required. It would cost less to pay higher domestic wages than to ship cheaper foreign manufactures. The straight economics in a peak oil world would favor local, domestic production that required less transportation.

    The US would remain susceptible to the increased cost of imported commodities, mainly oil, so to enjoy the upside of expensive transportation the US would have to engage in large scale conversion of its vehicle fleet to alternate fuels like domestic shale gas and electricity. Although it's probably politically impossible, a tax on fossil fuels to raise the price of gas would speed up this kind of conversion as well as induce conservation efforts. On the downside, raising fuel costs now would probably just tip millions more households into insolvency as their paychecks already barely cover their payments and basic living costs.

    As America's largest oil supplier, and with oilsands production able to increase this supply over the coming years and decades, Canadians spend their oil revenues buying US manufactures and other goods. Canadians shop in the US, vacation in the US, and buy vacation and retirement homes in the US south. An increase in US purchases of Cdn oil (and concurrent reduction of purchases of Venezuelan and other 'unfriendly' oil) will generate an almost equal increase in Cdn demand for what the US has to offer. This is what a "trade" relationship is supposed to look like, balanced. You get what we have to offer and we get what you have to offer. Both economies benefit. And due to America's cost advantage in upgrading and refining, shipments of Cdn oilsands crude through the new Keystone pipeline directly generates lots of well paid US jobs.

    In any event, I think it is becoming clear at higher levels up the economic policy foodchain that reducing the grip of finance and restoring America's productive economy and jobs are both necessary if America is ever going to emerge from its current malaise.



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