Sunday, January 11, 2009

Kalecki - Levy Analysis onCorp Profits and Obama Biden Plan

The good folks at Levy Economic Institute are the keepers of the flame for the Minskian economic analysis. Minsky has regained popularity this year as Bill Gross used the phrase (think it was one of his bond guys which brought it to his attention) "Minsky moment", as in 2007 to 2008 crisis was the USA experiencing a Minsky moment.

A lot of folks started glomming onto the Levy Economic Institute website to get on board.

To date the doom and gloom folks had been applying Minsky to show we were "gonna get it and get it good", applying the key "instability" thesis of Minsky - noting the three phases of economic dynamics from "hedge" to "speculative" to "ponzi" stages - with of course us always being in the "ponzi" stage and going to hell. Well, in finally happened and in this light Minsky guys flying high.

But I came across Minsky when I got to know Jack Nash in the last 80s, trying to get a berth as his bond guy. That didn't happen as the psyche tests Jack applied indicated I was "too nice a guy" - a problem many will testify I worked hard to remedy over the years since. But Jack seemed to like me and I guess to mollify me he gave me a book written by his partner Leo Levy's father Jerome Levy on how American corporate profits were determined by an analysis of public sector deficit/surplus, private sector savings, trade, and corporate investments - the "Kalecki-Levy Formula". Jack said this is how Odyssey made their money, so I sat up and paid attention.

So over the years I have used and read with great interest all the Levy Institute stuff not to be a prophet of doom but to make some money as per Jack. This was perhaps the using Minskian ideas for the "dark side" but it sure worked for me. I found a major flaw is that those who use
Minskian analysis is that the "instability" aspect of Minsky's work was thought to indicate that of
course we were "gonna get it and get it good". Minsky clearly takes a more balanced approach and rather than portray "instability" as proof modern capitalism is flawed, he cheerfully said it was a natural state of democratic liberal capitalistic systems and was a function that showed the danger but also in Schumpeter like way was an engine of great achievement.

The core function that is used throughout the Minskian models is Kalecki-Levy formula (K-L)- a fascinating story is how two geniuses - one making buttons ad the other a major socialistic European economists both arrived at the derivation and identified the importance of corporate profits in the analysis of Western capitalistic economies. Jerome Levy derived the formula to try and manage his inherited "notions" business through the turbulent first half of the 20th C while Kalecki was part of the academic economic criticism of the American capitalistic structure.

It makes perfect sense that profit dynamics would be a key driver of capitalistic economies - but even to this day it seems only those Keynesian economics with a Minskian bend hold it front and center.
The K-L formula in essence, taken from this paper: Profits: The Views of...Kalecki...Levy" 2000 from the Levy Institute :

Corp Profits after-tax = Corp Investment + Private Sector Investment + Net Trade + Actual Deficit Spend - Savings

Minskians use this identity to map out both the instability implicit (volatility) in the economy but also once corporate profits are identified by the more easily predicted public sector flows, prescience can be provided for GDP and thereby equity markets. Ergo why Jack Nash claimed this is how they made all their money.

It can bring insight in considering major watershed events and qualify public response. Application of the Kalecki Levy is the best way I know of to figure out what the SPX will do in 2009 given the Obama-Biden Plan.

Based upon this use of K-L, I was dismayed to find the O-B Plan intends to use a large chunk of the deficit spend in the form of tax cuts. The K-L identity will only count actual deficit spend and assume tax cuts or changes are just part of savings.
My simple table of a K-L breakdown if the O-B as written is what we get:

Notice the disastrous plunge in corporate profit and the move to 7% to 8% savings rate such an environment would bring. This would likely be commensurate with an SPX earnings below $40. The graph of this disaster is:

And the likely results in GDP and investment and Profits in nominal dollars:

I think I have gotten all the identities basically right. Obama Biden as written suggest we enter a depression.
Now, what amount of fiscal stimulus is required - and again I mean actual public sector spend, not counting tax adjustments as spend - to maintain 4th Q 2007 corporate profits. I assume savings continues upwards but not as much as some reduction of fear will result, though I assume corporate investments do not change.
The table:

This graphs out to a slowdown in GDP as savings still increase but not as much as with the O-B Plan as written and with the savings increase and corporate drop in investments offset by fiscal stimulus spend:

And the nominal dollar results that likely results with this true spend increase of $1.2 trillion in fiscal stimulus. Corporate gross investments still drops sharply but the fiscal stimulus is enough to keep corporate profit intact and also maintain GDP:

This would have the recession behind us and SPX earnings for 2009 be in excess of $70. Unemployment would start to improve by second quarter and likely back towards 6% by this time next year.

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