Value of the Financial Sector and Soundness of Money

gold-bullionIn a discussion about capital gains taxes and the value that the financial industry has to offer, I said this:

There is value in the work that these people do. They’re excellent allocators of resources, for one. They aide in creating bigger profits to other entities.

The thing is, people defend the idea of low capital gains taxes as if it is a necessity, or some kind of right. I agree with people who argue that taxes shouldn’t be different based on what the source of the income is – whether through labor or capital gains. It’s good to have a robust financial system because they specialize in allocation of resources, but the problem is that it can go overboard, like with the housing bubble.

Do we want a robust financial sector or do we want one bloated to the point that there’s so much competition, they resort to shady deals and business in order to be more competitive and turn a higher profit?

Lowering the capital gains tax did that. It bloated the financial sector from a single digit percentage of GDP to over a quarter of the entire economy. Since then, it’s only grown – albeit because the rest of the economy hash shrunk while the financial sector has recovered. This is not healthy, nor is there any reason to think it is.

A friend responded and said: “It gave the entire Bush era ‘false growth.'”

My response:

I once believed that and recall the first time I said people are playing with monopoly money in the USP forum (it was a Wednesday), but I don’t believe that anymore. Actually, saying that (or calling it “false growth”) is no different than what the Ron Paul-ites say when they argue against inflation.

No, it was true growth. The problem is that when the Federal Reserve did not respond to the demand for more money in 2008, the Fed literally DESTROYED that growth. Then, and only then, was that growth a “false growth” or playing with Monopoly money. Money is money; it is not more true or false than it was yesterday. There is nothing of value to money other than the ability to promise it and to deliver it. When the Federal Reserve effectively tightened money in 2008 by not responding to that demand of it so people companies could deliver on those promises, that money was destroyed – in the same way that money is destroyed in a Chapter 7 bankruptcy.

What the Federal Reserve did was decide to limit nominal GDP growth. Yes, that meant there would be inflation, but that inflation would have been no more false than the money that was promised. If it had been accommodative, we wouldn’t be in a recession today. TARP would have done its job – the bank system would have been saved. Along with that, debts would have been easier to pay because of the higher nominal growth. It’s easier to pay off a $1 trillion dollar debt in an economy that is $30 trillion than it is in an economy that is $20 trillion. That is how higher nominal GDP would help deleverage debt in the US. THAT is the ONLY way to get out of this recession.

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