Streetwise

Lauren Rudd

Sunday, April 15, 2012

It Comes Down to Leadership

It should come as no surprise that the ties between Wall Street’s ongoing performance and the economy’s health are inextricably linked. Therefore Wall Street is taking more than a passing interest in the newly minted budget proposal passed recently by the House of Representatives.

Akin to plucking profundities out of thin air, the budget proposal is portrayed as either a path to prosperity or a road to ruin, as it proposes to transform Medicare, cut domestic spending to levels not seen since World War II and order up a drastic overhaul of the tax code. Yet, the overhaul’s details are unspecified, merely stating that the six existing income tax rates would be reduced to just two, 25 percent and 10 percent. The ensuing revenue loss would be made up by the repeal of unspecified tax credits and deductions.

Meanwhile, a report dated October 2011 by the nonpartisan Congressional Budget Office confirmed that income inequality has grown dramatically. During the past three decades, the top one percent of wage earners has seen their share of the nation's income more than double, while government policy has become less redistributive, meaning it has done less to reduce the concentration of income.

The CBO stated that from 1979 to 2007, the average inflation-adjusted after-tax income for the top one percent of wage earners grew by 275 percent. For the top 20 percent, it grew by 65 percent. In contrast, the poorest fifth of the population saw only an 18 percent increase.

As we suffer through the current economic conundrum, there is an outflow of deprecating comments that inflame and subsequently hinder efforts to effectively deal with the fiscal issues at hand. Nonetheless, do you really want to watch the hapless slide unmercifully into the abyss of obscurity and desolation as the continuing depredation, brought about by the unabashed lure of lobbyists’ dollars, trumps all other considerations?

Hopefully the answer is no. But then the tantalizing thought of lower tax rates wafts through the air. And without that nagging thought of a rising national debt to contend with, you could spend the extra money with a clear conscience.

However, would you really spend it in a way that contributes to greater economic activity and thereby lowers unemployment? It is unlikely because the marginal propensity to consume, or the amount of each additional dollar of income that is spent on goods and services, generally declines as income rises.

As Washington battles over macroeconomic issues, there are some, such as Best Buy, that find microeconomics to be an even greater challenge. The resignation of Best Buy’s CEO, Brian Dunn, due to, "personal conduct issues,” prompted a flurry of Best Buy obituaries. The theory is that Best Buy is dying because the free standing store model is obsolete. The hypothesis is that it is impossible for brick-and-mortar stores to compete with Web-based retailers such as Amazon.

Although Best Buy's margins narrowed over the last five years, in no small part due to a price war with Amazon, Amazon's margins positively collapsed with the addition of free shipping to sustain sales growth. And sales growth is the metric Wall Street is fixated on in judging Amazon’s shares. There is no doubt consumers increasingly prefer buying from Amazon. However, rather than turn its growing sales dominance into higher profits, Amazon appears to lose money on incremental sales, given that sales growth has resulted in lower net income.

And while Amazon's Internet strategy has Best Buy reconsidering its approach to retailing, here is the irony. Rumor has it that Amazon is considering opening brick-and-mortar outlets. One theory is that Amazon in doing so would deepen its relationship with customers, while providing hands-on demos and customer service, much like Apple and Barnes & Noble are doing.