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May 10th, 2011

I think there are two major, semi-independent problems with the economy:

1) Real wages for the middle and lower classes have been stagnant for the last few decades (particularly the last decade) while income for the top 1% has skyrocketed and continues to climb. The net effect of the above is that, due to massive improvements in efficiency and productivity, wealth generated by American businesses has gone up steadily for decades, nearly all of the benefit of this has accrued to the ownership class.

2) The speculators invented a crazy system of securities in the wake of financial deregulation which hinged on an unbelievably stupid application of the Gaussian copula function for estimating default correlation. This one mistake amplified what could have been a “normal” real estate bubble into a bubble of gargantuan proportions. The danger to the real economy was drastically worsened by the repeal of Glass-Steagall and the lack of regulatory oversight of the shadow banking system. As far as bubbles, they’re not all alike; I personally would much rather see a bubble caused by excessive speculation on actual companies (i.e., IPOs) than a bubble caused by speculation on synthetic securities whose value was based on a fantasy. At least venture capitalists are trying to build something new, and if we have to go through some mild crashes as a result, I think that’s worth some risk (the economic consequences of the tech crash of 2000 were far less severe than the synthetic¬† securities crash of 2008).

It seems to me that 1 and 2 are relatively independent problems. 1) is probably caused by the decline of unions, the rise of Ayn Rand thinking among the upper classes: the ownership class believes that it truly is virtually solely responsible for the generation of wealth, almost single-handedly taking all increases in proceeds and giving none of it to the people who actually do the work. Furthermore the drastic lowering of tax rates on the wealthy has further contributed to this steady, unfair imbalance. 2) is a problem of speculative bubbles and insulating the regular banking system from the speculative system. Obama addressed 2) to some degree with financial regulatory reform: the creation of a somewhat weakened Volcker Rule, intended to isolate speculative activity to some degree from the operation of “normal” banking, regulation of the shadow banking system, and so forth, but he has not yet significantly addressed 1).

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