Seeing yet another commodity bubble headline at USAToday , I feel compelled to make a short post on this topic, which had been my originally planned topic last week.
Over the last decade, there have been at least two speculative bubbles of considerable magnitude, one in stocks and one in real-estate. There might also be a third that has formed in commodities as well. Historically, speculation on of this magnitude is not common. Having back-to-back events indicates that there are forces present in the investment community that are fueling these events that probably weren’t present in the recent past, though might have been present in the early part of the 20th century.
There are many forces of change out there with the rise of far eastern economies and globalization. They are most certainly a big part of the rise in the price of commodities, which to some extent also drove the housing boom. However, there has been a change in behavior on the part of investment managers, corporate executives and bankers. The appetite for risk is ridiculously high. At the height of the internet stock bubble, buying shares on margin had greatly increased. This has continued with the private equity funds that have bought companies wholesale, largely with borrowed capital. Companies like Blackstone are not doing so well. In banking, the sub-prime crisis is an example of banks racing to discount the risk premium in their loans to get in on the “can’t lose” boom. The same mentality is common amongst company executives, who are only worried about the next quarter.
The important question is, what is happening now that is causing this appetite for risk to be prevalent? My answer is that the tax system isn’t forcing investors or executives to worry about having income in the future. This is because the tax code isn’t sufficiently progressive as to make it worthwhile to put off profits in the future. If I’m not going to pay significantly higher taxes on my second ten million than my first ten million, why should I not try to cash out immediately? This leads to the decision to immediately monetize a brand or asset. This is why we’re seeing sequels out the wazoo in the movie theaters. Overexposure isn’t a concern, because there is a rape and pillage mentality. And it is all driven by the tax code which has ridiculously low taxes for unearned income and little increase in tax rate for high income. This is due in part to the consistent lowering of high tax bracket rates over the last twenty odd years and the income of the very wealthy growing far beyond the scope of the tax schedule.
Having made the argument that taxes on the very wealthy are lower than is healthy for our economy, I will also counter that we don’t want the top 10% of earners paying 30+% either like was the case in the 70s. My concern is more with the top 0.1% and above to make sure that they have some disincentive to not cash out all of the opportunities they have. There needs to be more disincentive to only think about today. There needs to be better accountability for money managers and corporate executives when things go wrong for this to happen, but there also needs to be a change in the incentives for investors so they will not want someone that only cares about today handling their assets.