Robber Baron or Robinhood?

According to Robert Pollin, an economics professor at the University of Massachusetts, the Bush administration is not going to enjoy the advantageous buoyancy of a stock market bubble – the dividend tax cut not withstanding.

Pollin argues that the U.S. stock market is currently valued at roughly twice its historical average, based on price/earnings ratios, and that this high valuation takes place at a time of general over-capacity. The dividend tax-cut justifies some increase in valuation: the after-tax value of dividends is now higher and so the stocks that produce them (and those expected to eventually) are now worth more. How much more depends on the tax-bracket of the shareholder, but the biggest gain is in the highest tax-bracket: roughly 30%. Clearly this alone doesn’t justify a market valuation twice its historical average.

With many firms producing at less than capacity – the result of over-ambitious capital expenditure during the boom years – there’s no reason to expect profits to catch up with valuations anytime soon. Furthermore, despite Sarbanes-Oxley, there are still questions about earnings quality – accrual accounting necessarily leaves management significant leeway in how earnings are booked, so conformity to Generally Accepted Accounting Principles (GAAP) is no guarantee of straightforward financial reporting.

Pollin is right that there’s a lot to be pessimistic about, and that there’s nothing the Bush administration can do to "re-inflate" the bubble. But let’s not forget that the fin de siècle stock market bubble, though it formed, floated upwards and eventually popped during the Clinton years, was not a result of Clinton administration policy, just as any new bubble, however unlikely, will not be the result of Bush administration policy.

Yes, there were favorable economic conditions in the mid/late nineties that helped to foster a strong bull market, and the Clinton administration deserves some measure of credit for that (though if you believe Ronald Reagan was instrumental in ending the Cold War, then his administration deserves far more). But the "irrational exuberance" of the late nineties was irrational precisely because it wasn’t based on economic calculation. The wild stock prices and resulting paper wealth of the late nineties was based on – more than anything else – a then prevalent belief that things are different now.

How many respectable business and economic publications featured cover stories on "The End of the Business Cycle"? How many well-credentialed pundits claimed that technology-spurred increases in efficiency had led to productivity levels that virtually ensured the continued growth of wealth in the U.S.?

More directly to the point, how many times did you hear or read the words new and economy used together without the slightest hint of irony?

As Pollin points out "many market analysts claimed during the bubble years that historic stock-price-to-earnings relationships no longer applied." As a former research analyst at a Boston-based investment firm, I saw first hand widespread contempt for traditional value-based methods of security analysis. More than one financial executive told me "Graham and Dodd is obsolete" (in reference to the classic Security Analysis, first published in 1934). And, by the way, those were the guys who were making the most money at the time.

Market conditions that lead to an unprofitable Internet retailer having a larger market cap than the world’s largest aerospace manufacturer do not result from White House policy. And if they ever did, we would be well advised to vote in a new administration. Pollin’s implied point is that by instituting a dividend tax cut the Bush administration is trying inflate stock market valuations, but "because Bush has taken no steps to avoid the excesses of debt and industrial capacity that built during the Clinton years, the likelihood is that a renewed stock market boom would not produce stable and sustainable growth."

But is this really a fair criticism? Of course the Bush administration would like to see a stock market boom. Bush presumably wants to be reelected and there’s no question a strong, sustained rally would help. A majority of Americans now have a stake in the stock market, and they’d like to be richer rather than poorer – even if only on paper. But the dividend tax cut can be defended on traditional supply-side grounds, or even by basic conservative arguments. The same kinds of arguments could be used to defend the administration’s inaction regarding "excesses of debt and industrial capacity built during the Clinton years." Pollin may think that government action on that front would have better long-term consequences than simply letting the market shake things out, but conservatives don’t.

Bush critics need to make up their minds: is Bush a right-winger trying to put money into the pockets of his rich cronies at the expense of the majority, or is he a cynical populist trying to jack-up the stock market to help his reelection effort? Of course a possible reply is that he's both; but without taking the position that stock markets are fundamentally irrational (an obvious absurdity), that comes dangerously close to admitting that supply-side economic policies benefit the average American.