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The origins of the economic crisis

A good way to understand the origins of the current economic crisis in Australia is to examine the historical behaviour of key macroeconomic aggregates. The previous Federal Government claimed they were responsibly managing the fiscal and monetary parameters and creating a resilient competitive economy. This was a spurious claim they were in fact setting Australia up for crisis. The reality is that the previous government created an economy which was always going to crash badly.

The global nature of the crisis has arisen because over the last 2-3 decades most Western governments including the Australian government succumbed to the neo-liberal myth of budget austerity and introduced policies which allowed the destructive dynamics of the capitalist system to create an economic structure that was ultimately unsustainable. Once this instability began to manifest it was only a matter of time before the system imploded – as we are now seeing.

You can understand my take on this story by looking at the following graphs that I have put together (click on each graph for a larger version). This short blog is a summary of a major study I am conducting on this issue.

The first graph is the so-called “sectoral balances” which plots the Budget Deficit (-), the Current Account balance (- for deficit) and the private domestic balance (difference between Saving and Investment; – for deficit) as a per cent of GDP. The sectoral balances is another way of viewing the national accounts and provides empirical evidence for the influence of fiscal policy over private sector indebtedness. Consider the accounting identity drawn from the national accounts for the three sectoral balances:

(S – I) = (G – T) + (X – M)

The Equation says that total private savings (S) is equal to private investment (I) plus the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents. Thus, when an external deficit (X – M < 0) and public surplus (G – T < 0) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process.

The graph shows the sectoral balances for Australia. While the current account deficit has fluctuated with the commodity price cycle, it has continued to deteriorate slightly over the longer term. Accordingly, the dramatic shift from budget deficits to surpluses from the mid-1990s onwards has been mirrored by a corresponding deterioration in private sector indebtedness.

The only way the Australian economy could keep growing in the period after 1996 was for the private sector to finance increased spending via increased leverage. As I have explained in other blogs, this is an unsustainable growth strategy. Ultimately the private deficits will become so unstable that bankruptcies and defaults will force a major downturn in aggregate demand. Then the fiscal drag compounds the problem.

The solution is simple. The government balance has to be in deficit for the private balance to be in surplus given a relatively stable external balance. In terms of the slightly worsening current account deficit, we can interpret that as signifying an increased desire by foreigners to place their savings in financial assets denominated in Australian dollars. This desire means that that the foreign sector will allow us to enjoy more real goods and services from them relative to the real goods and services we have to export. We note that exports are always a “cost” while imports are “benefits”. As long as there is a foreign desire for our financial assets, the real terms of trade will provide net benefits to Australian residents which manifests as the current account deficit. An external deficit presents no intrinsic problem despite views by the orthodoxy to the contrary.


In the second graph you can see that real wages have failed to track GDP per hour worked (in the market sector) – that is, labour productivity. Real wages fell under the Hawke Accord era which was a stunt to redistribute national income back to profits in the vein hope that the private sector would increase investment. It was based on flawed logic at the time and by its centralised nature only reinforced the bargaining position of firms by effectively undermining the traditional trade union movement skills – those practised by shop stewards at the coalface. Under the Howard years, some modest growth in real wages occurred overall but nothing like that which would have justified by the growth in productivity. In March 1996, the real wage index was 101.5 while the labour productivity index was 139.0 (Index = 100 at Sept-1978). By September 2008, the real wage index had climbed to 116.7 (that is, around 15 per cent growth in just over 12 years) but the labour productivity index was 179.1.


What happened to the gap between labour productivity and real wages? The gap represents profits and shows that during the neo-liberal years there was a dramatic redistribution of national income towards capital. The Federal government (aided and abetted by the state governments) helped this process in a number of ways: privatisation; outsourcing; pernicious welfare-to-work and industrial relations legislation; the National Competition Policy to name just a few of the ways. The next graph depicts the summary of this gap – the wage share – and shows how far it has fallen over the last two decades.


The question then arises: if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses which squeezed purchasing power in the private sector since around 1997.

In the past, the dilemma of capitalism was that the firms had to keep real wages growing in line with productivity to ensure that the consumptions goods produced were sold. But in the recent period, capital has found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits. Along the way, this munificence also manifested as the ridiculous executive pay deals that we have read about constantly over the last decade or so.

The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers. The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.

The next graphs shows various perspectives on the increasing household indebtedness in Australia. The left hand chart shows the spiralling in the debt to disposable income ratio which stood at 69.1 per cent in March 1996 and by September 2008 had risen to a staggering 156.1 per cent. It was often argued by the Government, the RBA and so-called financial industry experts during the build up period that there was no call for alarm because wealth was growing along with the debt. Well the debt was increasingly purchasing volatile assets other than housing and a fair proportion of the wealth created during that period has gone but the debt remains. The right hand chart shows the servicing burden (interest payments as a percentage of disposable income). This ratio has risen from 5.7 per cent in March 1996 to 15 per cent in September 2008, further squeezing the living standards of the household sector.



The problem with this strategy is that is was unsustainable. Household savings went negative as the government budgets went further into surplus. The next graph shows this clearly.


The only thing maintaining growth was the increasing credit which, of-course, left the nasty overhang – the precarious debt levels. I said years ago that this would eventually unwind as households realised they had to restore some semblance of security to their balance sheets by resuming their saving. Further, this increased precariousness of the household sector meant that small changes in interest rates and labour force status would now plunge them into insolvency much more quickly than ever before. Once defaults started then the triggers for global recession would fire and the malaise would spread quickly throughout the world. I was often criticised by conservatives and neo-liberal types for “crying wolf”. They kept harping on the fact that wealth was rising. Well the wealth has been severely diminished in the crisis but the nominal debt and the servicing commitments remain.

The return to deficits is the first step in recovery. Budget deficits finance private savings and are required if the household balance sheets are to remain healthy. Real wages also have to grow in proportion to labour productivity for spending levels to be maintained with sustainable levels of household debt. The household sector cannot dis-save for extended periods.

In designing the policy framework that will sustain growth in employment and reduce labour underutilisation these tenets have to be central. It also means that the massive executive payouts both in the private and public sector (including universities) have to be stopped and more realistic distributional parameters (more widely sharing the income produced) have to be followed.

Further, the first thing the Federal government should purchase is all the labour that no-one wants. By introducing a Job Guarantee they could offer a minimum wage to all those who wanted work and therefore restore full employment at a fraction of the investment they are proposing to make by way of fiscal stimulus.

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    1. The Precarious State of Family Balance Sheets


      The U.S. economy is five years removed from the Great Recession, and most national indicators point to a
      steadily increasing recovery. The stock market has more than doubled since its low in 2009, housing values
      have slowly increased nationally, foreclosure rates have declined for four years in a row, and unemployment has continued to trend slowly downward from a high of 10 percent during the recession to the current 5.6 percent.1 But these aggregate statistics obscure the financial insecurity that many Americans still face.

      Between 2010 and 2013, most household incomes fell, particularly among families of color and those without
      postsecondary education.2 Over that period, stock ownership decreased for households on all but the top 10
      percent of the income ladder, with a particularly steep decline among those on the bottom half.3 And almost a third of working-age adults reported having no retirement savings or pensions.4

      It is not surprising, then, that recent public opinion polling found American adults pessimistic and anxious about the economy and their own economic stability. They question whether the American Dream is within reach, and many doubt that their children will fare better than they have.5

      This report seeks to develop a clear picture of the current state of household financial security. It begins by
      exploring three components of family balance sheets—income, expenditures, and wealth—and how they have
      changed over the past several decades, and concludes with an examination of how these pieces interrelate and why understanding family finances requires that they be examined holistically.6 Taken together, the data in this study reveal a striking level of financial fragility:

      •• Although income and earnings have increased over the past 30 years, they have changed little in the past
      decade. The typical worker had wage growth of 22 percent between 1979 and 1999 but just 2 percent from
      1999 to 2009.
      •• Substantial fluctuations in family income are the norm. In any given two-year period, nearly half of
      households experience an income gain or drop of more than 25 percent, a rate of volatility that has been
      relatively constant since 1979.
      •• The Great Recession eroded 20 years of consumption growth, pushing spending back to 1990 levels. Over
      the 22 years before the start of the downturn, household expenditures grew by 16 percent. But households
      tightened their purse strings after the start of the recession in 2007, and spending has yet to recover. As a
      result, the net increase in average annual household spending is just 2 percent since 1990.
      •• The majority of American households (55 percent) are savings-limited, meaning they can replace less
      than one month of their income through liquid savings. Low-income families are particularly unprepared for
      emergencies: The typical household at the bottom of the income ladder has the equivalent of less than two
      weeks’ worth of income in checking and savings accounts and cash at home.
      •• Even when pooling all of its resources—including from accounts that are potentially costly to access, such
      as retirement accounts and investments—the typical middle-income household can replace only about four
      months of lost income.
      •• Most families face financial strain across all balance sheet elements: income, expenditures, and wealth. In
      addition to being savings-limited, households face other financial challenges; just under half of families are
      “income-constrained,” reporting household spending greater than or equal to their income; and 8 percent are
      “debt-challenged,” with payments equal to 41 percent or more of their gross monthly income. Fully 70 percent of households face at least one of these problems, with many confronting two or even all three.

      The data tell a powerful story about the state of household economic security and opportunity: Despite the
      national recovery, most families feel vulnerable and stressed, and could not withstand a serious financial
      emergency. This reality must begin to change if the American Dream is to remain alive and well for future

    2. Excluded from the Financial Mainstream:

      How the Economic Recovery is Bypassing Millions of Americans

      “The quality of available jobs helps explain why many people are not benefitting from the recovery. Fully one-quarter (25.1%) of jobs are in low wage occupations, a four percentage-point increase over the prior year. These jobs are disproportionately held by women and workers of color.8 Across the board, average annual pay nationally continued nearly a decade of stagnation and actually fell between 2012 ($50,011) and 2013 ($49,808).”

      And, “Millions of Americans are being excluded from the economic recovery. However, for some, the degree of exclusion is more profound. Not only are these households not reaping benefits of an improving economy, they are living outside the economic mainstream, relegated to using fringe—often high-cost—financial services and products that trap them in a cycle of debt and financial insecurity. One in five households regularly rely on fringe financial services to meet their needs. Nationally, 55.6% of consumers have subprime credit scores, meaning they cannot qualify for credit or financing at prime rates. Outside the financial mainstream, high-cost predatory loans are often the only way to bridge the gap between income and the cost of meeting basic needs.”

    3. Stock Buybacks Are Killing the American Economy

      Profits once flowed to higher wages or increased investment. Now, they enrich a small number of shareholders.

      “President Obama should be lauded for using his State of the Union address to champion policies that would benefit the struggling middle class, ranging from higher wages to child care to paid sick leave. “It’s the right thing to do,” affirmed the president. And it is. But in appealing to Americans’ innate sense of justice and fairness, the president unfortunately missed an opportunity to draw an important connection between rising income inequality and stagnant economic growth.

      As economic power has shifted from workers to owners over the past 40 years, corporate profit’s take of the U.S. economy has doubled—from an average of 6 percent of GDP during America’s post-war economic heyday to more than 12 percent today. Yet despite this extra $1 trillion a year in corporate profits, job growth remains anemic, wages are flat, and our nation can no longer seem to afford even its most basic needs. A $3.6 trillion budget shortfall has left many roads, bridges, dams, and other public infrastructure in disrepair. Federal spending on economically crucial research and development has plummeted 40 percent, from 1.25 percent of GDP in 1977 to only 0.75 percent today. Adjusted for inflation, public university tuition—once mostly covered by the states—has more than doubled over the past 30 years, burying recent graduates under $1.2 trillion in student debt. Many public schools and our police and fire departments are dangerously underfunded.

      Where did all this money go?

      The answer is as simple as it is surprising: Much of it went to stock buybacks—more than $6.9 trillion of them since 2004, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network. Over the past decade, the companies that make up the S&P 500 have spent an astounding 54 percent of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, or roughly 4 percent of GDP, to prop up their share prices by repurchasing their own stock.

      In the past, this money flowed through the broader economy in the form of higher wages or increased investments in plants and equipment. But today, these buybacks drain trillions of dollars of windfall profits out of the real economy and into a paper-asset bubble, inflating share prices while producing nothing of tangible value. Corporate managers have always felt pressure to grow earnings per share, or EPS, but where once their only option was the hard work of actually growing earnings by selling better products and services, they can now simply manipulate their EPS by reducing the number of shares outstanding.

      So what’s changed? Before 1982, when John Shad, a former Wall Street CEO in charge of the Securities and Exchange Commission loosened regulations that define stock manipulation, corporate managers avoided stock buybacks out of fear of prosecution. That rule change, combined with a shift toward stock-based compensation for top executives, has essentially created a gigantic game of financial “keep away,” with CEOs and shareholders tossing a $700-billion ball back and forth over the heads of American workers, whose wages as a share of GDP have fallen in almost exact proportion to profit’s rise.

      To be clear: I’ve done stock buybacks too. We all do it. In this era of short-term-focused activist investors, it is nearly impossible to avoid. So at least part of the solution to our current epidemic of business disinvestment must be to discourage this sort of stock manipulation by going back to the pre-1982 rules.

      This practice is not only unfair to the American middle class, but is also demonstrably harmful to both individual companies and the American economy as a whole. In a recent white paper titled “The World’s Dumbest Idea,” GMO asset allocation manager James Montier strongly challenges the 40-year obsession with “shareholder value maximization,” or SVM, documenting the many ways that stock buybacks and excessive dividends have reduced business investment and boosted inequality. Almost all investment carried out by firms is financed by retained earnings, Montier points out, so the diversion of cash flow to stock buybacks has inevitably resulted in lower rates of business investment. Defenders of SVM argue that investors efficiently reallocate the profits they reap from repurchased shares by investing the proceeds into more promising enterprises. But Montier shows that since the 1980s, public corporations have actually bought back more equity than they’ve issued, representing a net negative equity flow. Shareholders aren’t providing capital to the corporate sector, they’re extracting it.

      Meanwhile, the shift toward stock-based compensation helped drive the rise of the 1 percent by inflating the ratio of CEO-to-worker compensation from twenty-to-one in 1965 to about 300-to-one today. Labor’s steadily falling share of GDP has inevitably depressed consumer demand, resulting in slower economic growth. A new study from the Organization for Economic Co-operation and Development finds that rising inequality knocked six points off U.S. GDP growth between 1990 and 2010 alone.

      It is mathematically impossible to make the public- and private-sector investments necessary to sustain America’s global economic competitiveness while flushing away 4 percent of GDP year after year. That is why the federal government must reorient its policies from promoting personal enrichment to promoting national growth. These policies should limit stock buybacks and raise the marginal rate on dividends while providing real incentives to boost investment in R&D, worker training, and business expansion.

      If business leaders hope to maintain broad public support for business, they must acknowledge that the purpose of the corporation is not to enrich the few, but to benefit the many. Once America’s CEOs refocus on growing their companies rather than growing their share prices, shareholder value will take care of itself and all Americans will share in the benefits of a renewed era of economic growth.”

      $6.9 trillion

      54 percent of profits

      World’s Dumbest Idea

    4. The Middle Class May Be Under More Pressure Than You Think

      The Financial Pressures of the Middle Class

      “Using data from the Survey of Consumer Finances, Emmons and Noeth found that the median incomes of thrivers and stragglers were slightly higher in 2013 than in 1989, rising 2 percent and 8 percent, respectively. The middle class, however, experienced a decline in median income of 16 percent over the same period.

      Regarding wealth, thrivers experienced an increase in median wealth of 22 percent over the period 1989-2013. The middle class and stragglers experienced large declines, with the median wealth of the middle class dropping 27 percent and of the stragglers dropping 54 percent over the same period.

      Emmons and Noeth also examined the performance of each group relative to the population as a whole. They found that the median income of the middle class as they defined it grew 21 percent less than the overall median income from 1989 through 2013. The cumulative growth shortfall in wealth for the median demographically defined middle-class family was about 24 percent compared to overall median wealth.”

    5. Labor Productivity, Household Incomes and Corporate Profits: And the Winner Is?

      “The growth in labor productivity clearly hasn’t translated into higher incomes for median (aka middle class) households. Note that the household income data ends at 2013. The Census Bureau will publish the 2014 data in mid-September. That relatively flat blue line, showing a cumulative growth of 19.2% since 1967, is actually 8.7% off its peak, which occurred in 1999 as the market was entering the final phase of the Tech Bubble.

      So who actually benefited from the upward trend in labor productivity? Let’s look at an overlay of the Labor Productivity Index and a log-scale chart of Corporate Profits. On the recommendation of my friend Bob Bronson of Bronson Capital Markets Research, we’re using the series CPATAX in the FRED repository, which tracks corporate profits is after tax with inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj).

      Now let’s examine an overlay all three.

      Growth in Labor Productivity has been a boon to corporate profits, but not to household incomes.

      So much for the theory of trickle-down economics.”

      Last Chart:

    6. Can services prices mean price inflation is understated, not overstated?

      “This chart shows how the cost of cable has exploded over time”

      “This chart, from RBC Capital Markets’ Investment Strategy Playbook for July, is quite something.

      With little pause, the cost of a cable subscription has exploded over the years.

      We know that people are ditching pay TV for cheaper, contract-free streaming options like Netflix.

      And, according to data provided to BI Intelligence, the gap between the number of TV and internet subscribers keeps widening, with more people opting for broadband-only packages.”

      “The cost of cable subscriptions has doubled in the last eight years.”

    7. Is the annual pay raise dead?

      “”Base salary increases are flat. We don’t see the prospect of that changing much at all in the next several years,” said Ken Abosch, who studies compensation issues for Aon Hewitt.

      In other words, the annual raise is dead. It was already on life support last decade, but the Great Recession has finished off the raise. It’s been replaced by “variable compensation” — the bonus. (See the chart from Aon Hewitt below.)

      “The quiet revolution has been the change in compensation mix,” Abosch said. “Through a series of recessions, organizations have pulled back dramatically on fixed costs. And base salaries are often a company’s most significant fixed cost … [They] have a compounding effect, and create a drag on an organization’s ability to change.”

      In a perfect world, variable compensation allows companies to align corporate and worker incentives, and it rewards high performers and hard workers. It also allows companies to pull back on employee costs during hard times without resorting to layoffs.

      In reality, switching from raises to bonuses has mucked up a lot of things. For starters, it’s hard to make long-term financial plans with such short-term financial commitments from your employer. It’s nerve-wracking to take on a 30-year mortgage if your income is $100,000 this year but might be $80,000 next year.

      Workers also complain that the relationship between performance and bonus is often indirect — determined by factors outside their control, such as turnover in other departments or the overall economy.

      In a larger sense, when a substantial portion of a worker’s compensation is unpredictable, one benefit of full-time work fades. The “bonus” employee ends up in the same boat as an independent contractor, not quite knowing what their income will be in the future. The Aon and Towers Watson disagreement about funding of bonus pools speaks to the high degree of uncertainty that variable compensation can bring.”

    8. It’s Getting Harder To Move Beyond A Minimum-Wage Job

      “Minimum-wage jobs are meant to be the first rung on a career ladder, a chance for entry-level workers to prove themselves before earning a promotion or moving on to other, better-paying jobs. But a growing number of Americans are getting stuck on that first rung for years, if they ever move up at all.

      Anthony Kemp is one of them. In 2006, he took a job as a cook at a Kentucky Fried Chicken in Oak Park, Illinois. The job paid the state minimum wage, $6.50 an hour at the time, but Kemp figured he could work his way up.

      “Normally, a good cook would make $14, $15, $17 an hour,” Kemp said. “I thought that of course I’d make a better wage.”

      He never did; nine years later, the only raises Kemp, 44, has seen have been the ones required by state law. He earns $8.25, the state’s current minimum wage.

      Stories like Kemp’s are becoming more common. During the strong labor market of the mid-1990s, only 1 in 5 minimum-wage workers was still earning minimum wage a year later.1 Today, that number is nearly 1 in 3, according to my analysis of government survey data.2 There has been a similar rise in the number of people staying in minimum-wage jobs for three years or longer. (For a more detailed explanation of how I conducted this analysis, see the footnote below.)3

      Even those who do get a raise often don’t get much of one: Two-thirds of minimum-wage workers in 2013 were still earning within 10 percent of the minimum wage a year later, up from about half in the 1990s. And two-fifths of Americans earning the minimum wage in 2008 were still in near-minimum-wage jobs five years later, despite the economy steadily improving during much of that time.4”

      There is more in the article.

    9. Inequality in Our Retirement Accounts

      “In the Republican presidential debate Wednesday night, the issue of income inequality came up with surprising frequency. Why that happened is worthy of its own column; for now, let’s explore the issue with some recent data. Specifically, I want to consider inequality in the funding of our collective retirements.

      As a nation, we do a rather mediocre job preparing for the day we stop working. We underfund Social Security, a program originally developed to combat poverty among older Americans. As individuals, we fail to save enough to fund our own secure retirements.

      QuicktakeAmerica’s Retirement Gap

      To go deeper on the topic, let me direct your attention to Charley Ellis, founder of Greenwich Associates and former chairman of the Yale endowment. Ellis wrote the seminal investment book “Winning the Losers Game.” More recently, he co-wrote a sober explanatory book, including reasonable solutions, titled “Falling Short: The Coming Retirement Crisis and What to Do About It.” You can listen to our Masters in Business interview with Ellis here.

      In the meantime, consider this analysis by the Schwartz Center for Economic Policy Analysis at the New School for Social Research in New York. Using the most recent Census Bureau data, their analysis observed that “almost half of U.S. workers didn’t have a company-sponsored retirement plan in 2013, compared with 39 percent in 1999.”

      As Bloomberg News reported, “The lack of plans is fueling a retirement-savings crisis. Few workers save anything outside of employer-sponsored plans. Only 8 percent of taxpayers eligible to set aside money in an IRA or Roth IRA did so in 2010, according to the IRS.” Those statistics are simply awful.

      Forget for a moment the debate as to whether Social Security will be around (it’s easily made solvent). At present, Social Security benefits average $15,700 a year, far below what most people need to replace the median U.S. salary of $53,657.

      Then consider:

      • Half of U.S. workers lack company-sponsored retirement plans.
      • Only 45 percent of businesses with fewer than 100 employees offer 401(k)s.
      • Those who work part time, or switch jobs frequently, or work at a small company, are less likely to have an employer-sponsored retirement plan.

      It’s not just that the U.S. retirement situation is bad — it’s that it’s trending in the wrong direction.

      At the opposite end of the spectrum are the retirement plans of chief executives. As a group, not surprisingly, they are doing exceedingly well. As Bloomberg reported Wednesday, “The retirement savings accumulated by just 100 chief executives are equal to the entire retirement accounts of 41 percent of U.S. families — or more than 116 million people.” The 100 largest chief executive retirement funds are worth an average of $49.3 million per executive, or a combined $4.9 billion. All of these data points come from a new study by the Institute for Policy Studies and the Center for Effective Government.

      Some of the data points are quite astonishing: “Fortune 500 CEOs have $3.2 billion in special tax-deferred compensation accounts that are exempt from the annual contribution limits imposed on ordinary 401(k)s.” The CEOs managed to “save $78 million on their tax bills by putting $197 million more in these tax-deferred accounts than they could have if they were subject to the same rules as other workers. These special accounts grow tax-free until the executives retire and begin to withdraw the funds.”

      Why well-paid executives get a better tax deal than rank-and-file workers is not much of a surprise: They are the ones who can afford the lobbyists who insert these special dispensations into the tax code.

      So while we are debating income inequality, we should also be thinking about retirement inequality.

      Perhaps most vulnerable are the millennials, who came of working age in the midst of the Great Recession. There are 68 million wage-and-salary workers without a company-sponsored retirement plan, according to the Employee Benefit Research Institute. Millennials make up a disproportionate share of workers without a 401(k).

      This is unfortunate: Patrick O’Shaugnessy noted in his book “Millennial Money: How Young Investors Can Build a Fortune,” that as investors, millennials are planning for retirement in 40 to 50 years. Never again in their lifetimes will they have such a long time horizon.

      We have a looming retirement crisis. I have yet to hear a coherent solution from anyone from either party.”

      ***** So while we are debating income inequality, we should also be thinking about retirement inequality. ***** My emphasis.


      Research Affiliates: Where’s The Beef?

      “Key Points

      American households, pinched by rising prices at a rate higher than headline inflation, have generally not benefited from the unrelenting stimulus of quantitative easing and zero interest rates, and instead have experienced a decade of zero growth in income and spending power.
      The high valuations and low interest rates born of accommodative monetary policy lower forward-looking returns for both the wealthy and the middle class, but the middle class, who must invest today to prepare for retirement tomorrow, suffers relatively more.
      When the Fed eventually steps away from overt market interventions, capital market valuations should revert to more normal (i.e., lower) levels, which would bring with them more sensible forward-looking returns.

      The price of beef has been soaring over the past five years—up 80% cumulatively at the end of December 2015—but you’d never know it by looking at the official U.S. Consumer Price Index (CPI), which is up 7%, or 1.4% a year, over the same five-year span, and therein lies our beef. The developed nations of the world, are supposedly living in a low-inflation environment, at risk of tipping over into the abyss of deflation. That’s what the folks at the U.S. Bureau of Labor Statistics (BLS) tell us. And they should know, right?

      Well, maybe not. Surveys suggest that the average American’s daily experience may be quite different. One-year consumer inflation expectations have been consistently higher than trailing and realized inflation over the last 20 years, and higher than more recent market-based inflation expectations, measured by one-year swap rates. Figure 1 shows how this divergence has grown larger since the financial crisis, suggesting the average household might have been feeling even greater pain during the recovery process than has been believed.

      Since 1995, households have expected inflation to be, on average, 3.0%, whereas realized inflation has been around 2.2%, leaving an inflation “gap” of almost 0.8%. What explains this gap? The following is our hypothesis. The four “biggies” for the average American are rent, food, energy, and medical care, in approximately that order. These “four horsemen” have been galloping along at a faster rate than headline CPI. According to the BLS definition, they compose about 60% of the aggregate population’s consumption basket, but for struggling middle-class Americans, it’s closer to 80%. For the working poor, spending on these four categories can stretch to as much as 90% of total spending. Families have definitely been feeling the inflation gap, that difference between headline CPI and inflation in the prices of goods they most frequently consume.

      Since 1995, the average year-over-year inflation rate for energy has been 3.9%, for food, 2.6%; for shelter, 2.7%; and for medical care, 3.6%. If we strip out all other items and recalculate the index based exclusively on these four components, we find the average rate has been about 2.9%, right in line with households’ expectations. Let us be provocative. If inflation—as experienced by the average American—is higher than official BLS “inflation,” then what exactly is the BLS statistic measuring?

      It looks like the BLS thermometer is broken! Whatever temperature they show us, the actual temperature is higher, as experienced by the average American family. For instance, the reported CPI inflation over the past 10 years ending December 2015 was about 1.9% a year. If we focus on the “big four” over the last decade, the inflation that Americans experienced was about 0.5% more. Let’s call this 0.5% difference a “measurement bias.” Paradoxically, the inflation measures for these four categories are produced by the same people who assemble the CPI. Other sources peg the gap as being considerably larger.

      These considerations have a direct bearing on our prosperity. How much real growth, for example, has occurred in the past decade? Officially, GDP has grown 1.4% a year, over and above inflation. Over the same period, the U.S. population has grown by 0.9% a year. Thus, real per capita GDP has risen by a scant 0.5% a year. Subtract the 0.5% measurement bias—probably a conservative estimate—and the average American has experienced zero growth in personal spending power over the past decade. With wealth and income concentration, if the average is flat, then median per capita spending power must be lower. Comparing 2015 with 2005, this feels about right. The official statistics do not.

      The Great Recession begot a 5% reduction in U.S. real per capita GDP from the peak of 2007 to the trough of 2009. In the wake of the market collapse, major central banks around the world eased monetary conditions in lockstep with the Fed. It took nearly six years for U.S. real per capita GDP to regain its prerecession peak. This herculean task was achieved through massive spending and relentless borrowing from the nation’s current and future income. Has it worked? As always, it depends on whom you ask. We are deeply skeptical of claims that these massive interventions have helped. Real median household income has fallen by 4% since 2007, despite the “recovery” following the Great Recession! Comparing today to 1970, Figure 2 shows that real per capita GDP is up by 110%—more than doubling over the last 45 years! Yet, the median American has experienced less than one-fifth of this growth.

      Middle-class Americans are struggling, as are middle-class Japanese and Europeans. Easy money, asset purchases, and negative interest rate policies of central banks across the developed world are intended to ignite the “animal spirits” of the private sector. Are they instead stifling economic and wage growth? Are they stimulating asset hoarding and bubbles, which fuel widening gaps between the haves and the have-nots, and feed class resentment? Are they leaving inflationary pressures unchecked and hollowing out opportunities for the middle class? These are provocative suggestions, which go against neo-Keynesian theoretical dogma, but they fit the objective evidence we see all around us. Sometimes common sense trumps theory.

      Former Fed Chairman Ben Bernanke was quite candid in saying that zero interest rates and quantitative easing were intended to create a “wealth effect.” He wanted asset values to rise so the affluent would spend more, so the economy could boom. He achieved the first of these: asset values rose. But who owns assets? The wealthy. What this “stimulated” is a growing gap between the haves and the have-nots: the wealthy got wealthier. That’s redistribution, backwards. Then, in a towering act of hubris and hypocrisy, the central bankers collectively deny they played any role in widening the income and wealth disparity, or in hollowing out the middle class. Ouch. But although the rich began to spend more, the impact on the economy was limited. If the rich mostly buy more assets (i.e., stocks, bonds, real estate, art, collectible cars, rather than “new stuff” that needs to be manufactured), doesn’t that just fuel more bubbles?

      And let’s not forget the downside of bull markets. The benefits to the rich of accommodative monetary policy are short lived. The values of the assets they own soar, but the forward-looking returns on those assets crater. (Notice how hard it is to find a liquid mainstream market that offers real after-tax returns much above zero these days.) Then, net of spending and charitable giving, their wealth dissipates assuredly and rapidly, recycled into the economy with no assistance needed from the Pikettys of the world. The wealth of the richest is fleeting, typically dissipated by the third generation (Arnott, Bernstein, and Wu, 2015).

      Worse, lousy forward-looking returns also afflict the young and the shrinking middle class. The future returns on their pension assets are horribly low, but the average American must prepare for retirement now, not later when the artificial policy-induced bull market ends and prices settle to more sensible levels. As a result, they invest their hard-earned money in the S&P 500 and hope for the best. Unfortunately, hope is not a strategy. To add insult to injury, their kids have essentially zero incentive to invest for the future or to buy (not at today’s prices!) those self-same assets from their parents to help transform them into goods and services their parents can consume in retirement. Zero-interest rate policies have crushed the opportunities and incentives for the middle class—and their kids—to save and invest.

      The middle class is getting squeezed from every direction and is sadly disappearing. In 2008, according to Pew Research Center, 53% of adults considered themselves middle class. A scant 6 years later in 2014, as Figure 3 illustrates, that number had dropped precipitously to 44%. At this rate of decline, in 30 years there’ll be no middle class left! For the class warriors, don’t worry, be happy—the self-identified upper class has shrunk from 21% to 15% in that same 6-year span, so they’ll be gone in just 15 years!

      We’re being deliberately provocative; we do not expect this to happen because pendulums swing both ways. But this particular swing of the pendulum is profoundly disturbing and is doing a lot of damage to what was once called “American exceptionalism.”

      New business start-ups suffer too. Individual investors hesitate to fulfill their dreams of beginning their own businesses—home to the majority of our economy’s jobs—because they don’t know the cost of capital. Near-zero interest rates aren’t available to them, and the future cost of capital is unknown but presumed to be higher. The prospective regulatory regime three to five years hence is shrouded in mystery too. Corporations, like investors, are deeply wary about long-horizon investments with uncertain prospects. Why plow funds into long-term risky business ventures when low-risk (but, of course, high-priced) stock is available for buybacks and can be funded with near-zero-rate financing? The endgame is that the economy stagnates and the middle class slowly slips underwater. Is this speculation or fact? January 2016 was one of only a few months since the Great Depression with no IPOs.

      The fears surrounding the global economy and the calls for negative interest rates highlight the uncertainty surrounding the near future. When central banks finally step away from overt market interventions, however, capital market valuations will presumably revert to the levels that would prevail in the absence of intervention. Does anyone think that will mean higher price levels? Didn’t think so. Accommodative monetary conditions inflate asset prices into asset bubbles that sooner or later will seek their fair value. If the interventions are artificially propping up asset prices, the average investor is justifiably wary. If fair values are lower, the good news is that, after the one-off adjustment, forward-looking returns will once again be sensible.

      Big Brother cannot take care of us. Only we can do that. Big Brother is us; the government is us. If we think a bureaucrat can take care of us better than we can take care of ourselves, or cares more about us than we care about ourselves, we’re deluded. The more we think we can offload our own responsibility for self-reliance—the longer we take to look under the bun and ask, “Where’s the beef?”—the more we invite our elite leaders to continue with the interventionist policies that have inflicted so much damage already.”


      Just How Good (or Bad) Are All the Jobs Added to the Economy Since the Recession?

      With interactive data.

      At the end, “So were all the jobs we created since the recession bad? Well, yes and no. It’s true that many low-wage industries have been growing, many middle-wage industries have shrunk, and more people work part time or for minimum wage than did a decade ago. But it’s also true many middle- and high-wage industries are growing too, and the number of minimum wage and part-time workers has gradually been declining over the past five years.”


      See all including:

      “In fact, labor productivity has been growing at a higher rate than labor compensation for more than 40 years. As Figure 3 shows, labor productivity in 2016:Q1 is 3.8 times as high as that in 1950:Q1; labor compensation, on the other hand, is only 2.7 times as high. In other words, the gap between labor productivity and compensation has been widening for the past four decades (see Domenech, 2015, and Fleck, Glaser, and Sprague, 2011, for discussions of the widening gap). The slower growth in labor compensation relative to labor productivity during the recovery from the two most recent recessions is part of this long-term trend.

      The data in Figure 3 show that the productivity-compensation gap—defined as labor productivity divided by labor compensation—has been increasing on average by approximately 0.9 percent per year since 1970:Q1. Based on this long-term trend, the gap would have been 51 percent higher in 2016:Q1 compared with 1970:Q1; in the data, the gap is actually 47 percent higher.

      In conclusion, labor compensation failed to catch up with labor productivity after the 2007-09 recession. How­ever, the driving force behind it is not unique to the recent recession but is part of a long-term trend of a widening productivity-compensation gap.”

    13. Americans are now in more debt than they were before the financial crisis

      “Americans may soon exceed the amount of credit-card debt they racked up during the Great Recession.

      The average household with credit card debt owes $16,061, up 10% from $14,546 10 years ago and $15,762 last year, according to a new analysis of Federal Reserve Bank of New York and U.S. Census Bureau data by the personal finance company NerdWallet. The amount of household credit card debt is still down from a recent high of $16,912 in 2008 at the height of the recession. The U.S. won’t hit pre-recession credit card debt levels until the end of 2019, NerdWallet’s analysis projects.

      Total debt (including mortgages, auto loans and student loans) is expected to surpass the amounts owed at the beginning of the Great Recession by the end of 2016, NerdWallet found, mostly due to mortgages and student loans. Mortgage debt jumped from $159,020 per household in 2010 to $172,806 in 2016, and debt from auto loans grew from $20,032 in 2010 to $28,535 in 2016.

      Nationwide, total household debt (including mortgages, auto loans and student loans) now equals almost $12.4 trillion, up from about $11.7 trillion in 2010.

      Why the growth in debt, given that many consumers should be skittish about living beyond their needs after the credit bubble of the Great Recession? The reason concerns a problem that has long dogged Americans. Median household income has grown 28% over the last 13 years, said Sean McQuay, a personal finance expert at NerdWallet, but expenses have outpaced it significantly. Case in point: Medical costs increased by 57% and food and beverage prices by 36% in that period.

      Many Americans find it difficult to stick to savings goals. And that’s even worse if you have a family. The amount that a two-parent, two-child family needs just to pay the bills (but not have money left over for savings) ranges from about $50,000 to more than $100,000 depending on where a family lives, according to data from the nonprofit and nonpartisan think tank the Economic Policy Institute.

      Rent has risen 3.9% in the last year alone, according to the Bureau of Labor Statistics. “The economy is doing better, but we’re really not seeing that trickle down to individual households the way we’d hope,” McQuay said. Rising living costs mean, if anything, consumers should pay extra attention to their budgets in the next year, he said. “We’re allergic to the idea of budgeting,” he said. “It sounds just as awful as dieting.””

    14. Every industrial robot takes up to 6 jobs, study finds

      “Industrial robots could take over 6 million jobs in a decade, new research finds.

      Economists Daron Acemoglu of the Massachusetts Institute of Technology and Pascual Restrepo of Boston University say that at the high end of projected industrial robot takeup, there would be a 0.94 to 1.76 percentage point decline in the employment-to-population ratio by 2025. Though the authors didn’t quantify the jobs at risk, the Census Bureau projects the 2025 population to be 347.3 million people, meaning between 3.3 million and 6.1 million jobs could be lost.

      Even a more conservative projection of robot usage would imply a 0.54 to 1 percentage point decline in the employment-to-population ratio, or between 1.9 million and 3.5 million jobs lost.

      The authors studied the impact of rising industrial robot usage between 1990 and 2007. They found that each new robot per thousand workers reduced the employment-to-population ratio by about 0.18 to 0.34 percentage points, and wages fell between 0.25% to 0.5%.

      Another way to say that: between 3 and 5.6 workers lost their jobs for each robot added to the national economy.

      Industrial robots are fully autonomous machines, which do not need a human operator and can be programmed to perform several manual tasks such as welding and painting. (Coffee machines, cranes and elevators are not industrial robots because they have a unique purpose, can’t be reprogrammed and/or require a human operator.)

      The employment impact, the authors find, is most pronounced in routine manual, blue collar, assembly and related occupations, and for workers with less than a college education. At the same time, the authors don’t find any positive and offsetting employment gains in any occupation or education group, a finding they call a surprise.

      The authors also found that while the robot impact on men and women was similar, the impact on male employment was more negative.

      Another notable finding is that the impact from robots is distinct and weakly correlated to other factors such as Mexican and Chinese imports, offshoring and other computer technology.”

      EMPHASIS: “At the same time, the authors don’t find any positive and offsetting employment gains in any occupation or education group, a finding they call a surprise.”

    15. How fewer Americans are out-earning their parents — in one chart

      Making more money than mom and dad becomes less common

      If the American Dream means making more money than your parents, then here’s a chart that shows the dream is in trouble.

      The below chart — which comes from the journal Science — gives the percentage of Americans who are out-earning their folks by birth cohort.

      If you’re a WWII baby or boomer, you most likely pulled in more than mom and dad.

      But it’s become not as common for Generation X and millennials. (Hat tip to the Daily Shot for highlighting this graphic, which is our Need to Know column’s chart of the day.)”

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