Q: Isn’t this also because the profits for financial investment in asset bubbles are much higher than profits in manufacturing?
A: There’s a problem in terminology here, between technical economic jargon and popular understanding. Classical economists were careful to define the term “profit” to mean an economic gain made by investing in plant and equipment (capital) and employing labor to produce goods and services to sell at a markup. Profits were a return on tangible capital investment and current expenses on labor, raw materials and other inputs.
This is not how the financial sector makes its gains. Its interest, fees, commissions and penalties are the result of built-in, standardized legal privileges. Economists call these returns “economic rents.” Unlike profits, they are independent of the cost of production. Their “cost” consists of buying privileges, not of making tangible capital investment. The same is true of the other major element financial returns: asset-price (“capital”) gains.
A privilege is literally a “private law” (from the Latin legis, law), a monopoly right. The main privilege is to create bank credit and take deposits that are insured by governments, ultimately by public debt and the right to tax. These financial returns have an entirely different dynamic from commercial and industrial profits. They are made off the economy, not part of the economy’s physical and technological growth and capital formation. They are an overhead charge paid out of profits and wages.
In these respects, financial returns and profits are quite different dynamics. When a company is bought out on credit, the profits end up being paid out as interest rather than reinvested to expand production and employment. Financialized companies are treated much as absentee-owned commercial real estate: Buyers pledge the rent (in this case, the corporate profits) to the creditor who lends the credit for the purchase. Buyers may even pay depreciation (tax-deductible cash flow) to the banks and bondholders – hoping to squeeze out a capital gain or sell of the company’s parts for more than the whole is worth. Low-return divisions are closed down or sold off. The basic dynamic is shrinkage.
Paying out profit as interest leaves no reportable earnings. Interest is deemed a “cost of doing business.” But it is not a cost of production. It is financial overhead. And since the 1980s, growth in this overhead has absorbed and even outstripped the rise in productivity. Instead of living standards rising, the economic surplus has taken the form of a return to the FIRE sector, mainly the financial sector – commercial banks, investment banks, mortgage packagers and brokers, and so forth. Real estate owners gained during the bubble years as property prices rose faster than the bank debt that was inflating them. But the reckless junk mortgage lending and outright fraud led to a collapse of new lending after September 2008, leaving a residue of negative equity, bankruptcy, foreclosures and abandonments in its wake.
Companies that pay out all their cash flow as interest do not pay income taxes on this diversion of revenue, because interest is a tax-deductible expense. As for the financial engineers at the top – the class that has replaced industrial engineers – they aim to get rich not by earning profits, but by capital gains. These are taxed at much lower rates. So the financialized tax system encourages speculation rather than profit-making direct investment.
Suppose that a company earns $1 million dollars of profit in a year. About $400,000 must be paid in income tax. A corporate raider will buy the company’s stockholders (equity owners), for $10 million in junk bonds. The entire $1 million dollars of profit will now be paid to the banker or the bondholder in the form of interest. The company won’t report a profit, so there is no tax payment. The financial manager will hope to increase the company’s price (to re-sell it on the stock exchange) by cutting costs or selling off its pieces to make a capital gain. This is how Republican presidential candidate Mitt Romney’s Bain Capital made money. It is “balance sheet” engineering, not aimed at raising production or living standards.
That's really it in a nutshell, that's all it's ever been. The process has been accelerated over the last 15 years, with Saint Clinton's feckless Rubinizing of the economy, with the coup de grace of the Gramm-Leach-Bliley Act. But that's basically how it's worked all along. The peons went along with it for a while, as the stock market democratized slightly in the late '90s with the first tech bubble.
But since the economic implosion -- or, to put it more accurately, since the banksters forced the taxpayers to take on their bad debts -- real stock portfolios are strictly a rich man's game. Maybe you or someone you know turns a fair buck e-trading or something. Good luck with that, some folks manage to make a living playing Texas Hold 'em.
This is such a critical thing for non-financial people to apprehend more clearly. It spells out quite clearly that the financialization of the economy really means a system where the players get to write and change the rules of the game at will, and always, always at the expense of the vast majority of people who cannot afford to even get into the casino. Think about that for a second -- you are literally being forced to pay for a game that you cannot yourself afford to play. You are giving a handjob to the guy who just robbed your house and set it on fire, just because he could.
And again, after all this, it still hasn't been enough for these people. They want more, they're never happy with all they've gotten so they want to take it out of people who have to work multiple jobs just to keep the lights on, who are trapped under six-figure student-loan debt in a dead job market, who live on fixed incomes and choose daily between food and medicine.
This acceleration of rentier capitalism has resulted in such a hyperconcentration of wealth, it cannot help but be damaging to the society as a statistical aggregate. And so it has; unless one happens to be fortunate enough to live in some special enclave of prosperity, most of us can just look around and see for ourselves -- potholed roads, worsening schools, boarded-up businesses, abandoned strip malls, homeless people who have no substance or mental issues, no living-wage jobs.
It's damaging not because Class Envy, but because you really can only spend so much money. Spending money circulates it back into the economy right away. But your hyperwealthy Scrooge McDuck type doesn't spend money -- he's already got everything he wants, you can only have so many luxury items, houses, cars, etc. So he might hit a high-end restaurant, rent a $5K/night escort, throw a couple bones at the local philharmonic so as to keep up the appearance of philanthropism. But mostly they either "invest" it, which can take years to work its way back into the real economy (if it's even invested here in the first place), or they hoard it. Because you never know when you'll need a $100 million IRA.
Anyone who earns under $100K and is even thinking of voting for Buzz Killington Rmoney has got to understand that simple fact -- everything they hate about the economy, every opportunity they've missed out on, every job that's been downsized or outsourced or turned into a McJob, those are all things that Buzz considers a feature, not a flaw. He means to accelerate that process, to do it as much as possible.
And why not? Debt peonage isn't just about hyperconcentration of wealth, it has the ancillary benefit of hyperconcentrating power. Historically these conditions of hyperinequity have been found in pre-revolutionary societies -- France, Russia, China. The difference now, of course, is that the peasants are cowed by a powerful combination of apathy and hopelessness and perpetual debt, enabled by once unimaginable technologies, lulled by princess boobies and shows about opening storage sheds, kept under a watchful eye empowered with secret prisons and warrantless wiretapping.
An actual revolutionary movement would be Gitmoed in a heartbeat. Widespread grass-roots movements can either be co-opted by money and power (teabaggers) or cordoned off into the "free speech zone", to be hooted at by bankster molls like Erin Burnett, pepper-sprayed by thug cops, or infiltrated by a busload of rapists from Rikers.
Not that there's anything anyone can or will do about it, but it never hurts to keep one's eyes on the actual ball, and maybe eventually stop being gulled by Lucy with her damned football.