ThePlausibility of John Karls’ ChallengeToConventionalWisdom

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ThePlausibility of John Karls’ ChallengeToConventionalWisdom

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The Plausibility of John Karls’ Challenge To Conventional Wisdom

Disclaimers –

(1) As John’s daughter who works in Silicon Valley, I am aware that Bill Lee (whom I have never met) took offense at some of my comments a few months ago concerning his claim that a gasoline tax to fund social security and medicare similarly to the way European countries finance their social programs, would bankrupt the American trucking industry. I pointed out that all trucking companies would have the same cost increases and, accordingly, would be able to pass them through to customers. Therefore, the trucking industry would not go bankrupt but, to the extent that an increase in trucking fees might reduce slightly the overall demand for trucking (vs., for example, railroading), some of the trucking firms might have to retire their oldest, least efficient trucks – which would presumably be a good thing. Unfortunately, so that bulletin-board readers would take my comments seriously, I mentioned that I receivfed a double-degree in economics and electrical engineering from M.I.T. in 2005 but, I understand from my father, that Bill was offended by my mentioning the credential. I herewith apologize to Bill.

(2) My only other sibling, Michael, also inherited my father’s genes for majoring undergrad in Economics. And my father likes to use Michael as a “sounding board” for his ideas regarding economics in general, and in particular his challenge to the conventional wisdom that the “real estate bubble” caused the 2008-201? economic crash.

John’s proposition is that the American Jobs DESTRUCTION Act of 2004 caused the crash and, in so doing, the crash would have occurred whether or not there had been a “real estate bubble.”

Since MIT economists are notorious for being “numbers oriented,” it would appear that a few comments from me may be in order.

First, John is right that Greenspan and the CBO were ignorant if one wants to take the charitable view, and incompetent (or worse) if one is realistic. There were indeed TRillions of dollars in tax-haven subsidiaries of U.S.-based companies that represented the earnings accumulated over many years from having exported American jobs. And those Trillions of dollars had indeed been invested in short-term commercial paper of unrelated U.S. companies that had not exported American jobs.

Second, John is right that if Greenspan and the CBO had been competent and honest, they would have realized that there would be –

(1) TRillions of dollars of liquidations of that commercial paper beginning on 10/22/2004 and extending at least through 12/31/2005 (if not, as a practical matter as John pointed out, into 2006 and 2007).

(2) TRillions of dollars of stock redemptions by the U.S.-based companies that had exported American jobs as they suddenly obtained access to the years of profits from exporting those jobs.

(3) TRillions of dollars in contractions by the U.S.-based companies that had not exported American jobs as they were suddenly, in 2005 (and probably in 2006 and 2007), forced to pay off their debts to the tax-haven subsidiaries of the American-job exporters.


The information is not readily available.

Which is why economics professors love graduate students!!!

Because the research they perform for their economics courses in general, and their dissertations in particular, comprise “slave labor” for the professors!!!

And John’s theory would be a terrific subject for a PhD dissertation, and we would all benefit from the answers!!! [Particularly Greenspan, the CBO and, of course, our politicians (I won’t comment on the views of Richard Kuttner and Dana Milbank on whether they accept “campaign contributions” to enact such things as the American Job DESTRUCTION Act of 2004.)]

However, the reason for posting this comment is to call attention to the fact that the numbers that are readily available support John’s theory.

His time line pointed out that the dividends had to comprise “cash” between, as a practical matter, 10/22/2004 and 12/31/2005 – though the contractions in the U.S.-based companies that did not export jobs could easily have extended into 2006 and 2007.

Pausing for a moment, a healthy company that is unable to re-finance its commercial paper and, therefore, has to starve its operations for cash to repay the borrowings – has only two major sources in the short term = reducing/eliminating capital expenditures (including replacing its obsolete/obsolescent property) and reducing payroll which means, for the most part, terminating people. [Longer term options include reducing/eliminating dividends and reducing payroll through attrition rather than terminations.]

And for healthy companies to be forced to reduce their capital expenditures and payrolls by TRillions of dollars (if, indeed, they were so forced), one can begin to appreciate the repercussions for the economy as suppliers have to cut back and terminated employees have to tighten their belts in an unending chain reaction.

The reason for taking a look at the readily-available data is that I am aware that in their “brain storming” my brother Michael took the view with my father that the TRillions of dollars dividended from the tax-haven subsidiaries to the U.S.-based companies that had exported American jobs, and used by them to redeem stock – MIGHT have been used by the shareholders (largely pension funds, university endowment funds, mutual funds, hedge funds, etc.) to make loans to the U.S. companies that had not exported American jobs and that were being forced to pay off their TRillions of dollars of short-term borrowing from the tax-haven subs.

In other words, the TRillions of dollars MIGHT have traveled in a complete circle which, in total, amounted to a “big nothing.”

You may recall that John’s theory was that the stock redemptions resulted in a “stock market bubble” in mid-2006 and, for example, the Dow Jones has never approached the mid-2006 levels again.

In other words, the TRillions of dollars of profits over many years from exporting American jobs were largely re-invested in the remaining stock creating a “stock market bubble” which disappeared into “thin air.”

The readily-available data support John’s theory!!!

The market capitalization of the S&P-500 on 12/31/2008 was slightly over $12 trillion AND INCREASED BY SLIGHTLY MORE THAN 5% DURING THE NEXT 18 MONTHS!!!

[Market capitalization of the S&P-500 is the total value of all of the stock of all 500 companies that are included in the S&P-500 stock-market index.]

If several TRillions of dollars of cash came out of the S&P-500 companies as stock redemptions and was NOT re-invested in the remaining stock of S&P-500 companies, one would expect in general that the market capitalization of the S&P-500 would decline by the several Trillion dollars.

[In simple terms, if you have a “piggy bank” that contains $12 dollars and you suddenly remove $5, you would probably expect the remaining value of the contents of the “piggy bank” to be $7.]

Instead, the $12 TRillion market capitalization of the S&P-500 actually ROSE BY SLIGHTLY MORE THAN 5% between 12/31/2004 and mid-2006!!!

This suggests that the stock-market investors (predominantly pension funds, university endowment funds, mutual funds and hedge funds) used the TRillions of dollars they received in stock redemptions to, in the first instance, bid the price of the “piggy bank” back to 105% of its value despite the removal of a substantial chunk of its contents.


However, the astute reader/economist/accountant will realize that this does NOT solve the riddle of where the TRillions of dollars ultimately went in the second and subsequent instances, because absent such things as redemptions or new stock issuances (IPO’s), the amount of stock certificates of the S&P-500 companies is constant and it is merely the value of the finite number of certificates (the S&P-500 market capitalization) that fluctuates.

In other words, if the stock market investors bid the price of the “piggy bank” to 105% of its former level despite the removal of a major chunk of the assets of the “piggy bank,” it is true that a “stock market bubble” has been created but it is also true that there have been as many stock certificates sold as the number of stock certificates purchased with the sudden “windfall” of TRillions of dollars that landed initially in the hands of investors in the stock of American companies that had exported American jobs.

So “net, net” where did the TRillions of dollars that landed in the hands of the net sellers of stock certificates go???

Many of the investors in the stock market (pension funds and mutual funds) face legal restrictions regarding the types of investments they can make.

University endowment funds are free to invest in anything they can persuade their trustees to spring for.

And the same is true for so-called “hedge funds” which is a misnomer because “hedge fund” technically denotes funds in which the investors are large and sophisticated enough that there are no legal restrictions on what they can invest in.

Having said all that, all four types of investors just discussed diversify their portfolios among various types of investments and only change those allocations slowly over time. Which is probably why, in the first instance as described above, the market capitalization of the S&P-500 rose by slightly more than 5% from 12/31/2004 to mid-2006 despite the removal of a major chunk of the assets in the S&P-500 “piggy bank”!!!

It would be a major undertaking to ascertain and compile the data on what those investors finally did, in the second and subsequent instances, with the TRillions of dollars that had suddenly come out of the “piggy bank.”

Obviously a good topic for a top-drawer MIT economics PhD student to tackle for her/his dissertation.

But perhaps a “tilt at windmills” because a good deal of the data that needs to be ascertained and compiled may not be publicly available.

My father did not receive his undergraduate economics degree from MIT and, therefore, he is excused for being more theoretically oriented than constrained by data.

His theoretical guesses regarding where the TRillions of dollars ultimately went???

(1) That the overwhelming majority of it was probably reinvested by the various types of funds in the pre-existing allocation among categories of types of assets – which only “begs the question”!!!

(2) But that the question is irrelevant to what caused the 2008-201? Economic Crash because the TRillions of dollars certainly were NOT channeled back to any great extent into the commercial paper of the U.S.-based companies that had not exported American jobs AS EVIDENCED BY THE WIDESPREAD MEDIA REPORTING THAT BANKS AND OTHER LENDING INSTITUTIONS WERE NO LONGER MAKING LOANS TO SUCH COMPANIES (AS IF THEY HAD EVER DONE SO DURING THE YEARS THAT THE TAX-HAVEN SUBS OF U.S.-BASED COMPANIES THAT HAD EXPORTED AMERICAN JOBS WERE BUSY FULFILLING THE BORROWING NEEDS OF THE CHUMP AMERICAN COMPANIES THAT HAD NOT EXPORTED AMERICAN JOBS) – so those companies were still left to wring TRillions of dollars from the payroll and capital expenditures of profitable operations!!!

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