The Gini Coefficient is a measure of income inequality across a society. The higher the number, the greater the inequality. According to the CIA, the United States has a higher gini coefficient, hence higher inequality, than the following countries: Iran, India, Cameroon, Ivory Coast, Jordan, Ghana, and many, many more.
The middle class is the engine of democracy and real economic growth. When our gini coefficient is higher than several countries in sub-Saharan Africa, you know that we have a problem. It is higher than at any point since the coefficient has been recorded. This raises some questions. One, is our tax structure efficient? Two, what is GDP/capita if you don't include the top 10% of income earners? Three, why is the gini coefficient rising when US worker productivity has risen so sharply with the advent of modern communications? The answer to number three is obvious, but the other two will require more thought.
Friday, July 9, 2010
How the hell did we get here?
The 2008 financial crisis was the culmination of decades of reckless policies by the federal government. The culprit was ever-loosening credit, to the extent that the entire financial system became overladen with toxic loans. The former chairman of the fed, Alan Greenspan, exemplified the naive belief that, by spreading risk, the over abundance of easy credit would not result in collapse. Whoops! But why was loose credit so necessary to our economy? Three words:
Stagnant Real Wages
Nominal wages are simply the dollar amount you bring home. Real wages are that amount compared to the prices of goods. Real wages matter, nominal wages do not. Since 1973, the real wage of the middle class has decreased. This raises serious questions. The most obvious question is why real wages have stagnated. But the most important question for this post is "how is it possible that real wages stagnated but our standards of living increased?"
Loose Credit
As wages stagnated, there was only one mathematically possible way to improve the standard of living of the middle class: loose credit. Politically, this was the only acceptable route. The fed is supposed to be politically independent, but decided that its job was to improve the standard of living of the American People rather than ensuring financial stability. Whoops!
With the collapse of the credit markets in 2008, we entered dangerous waters. Frozen credit combined with stagnant -in fact lower- levels of wages relative to 1973 puts the middle class in severe danger. Every single aspect of the American economy which relied on easy credit, such as retail, home buying, and construction, are now dependent on stimulus to keep them afloat. Why? Because without credit to prop up the economy, government spending must do the job. Infrastructure IE "shovel ready" projects are intended to fill in for construction. Tax credits prop up home sales. Tax cuts are intended to prop up retail.
Damage is being done not only to people and businesses that were on top of the credit bubble, but also to those that deserved to have good credit all along. Now, they can't get loans either because banks are risk averse. Banks are risk averse because there are still hundreds of billions, perhaps over a trillion, in toxic assets out there, and future uncertainty. So because of this, small businesses which pose nominal or moderate risk, and which should be the drivers of a recovery, cannot get the loans and investment needed to grow and hire more people.
Meanwhile, big businesses, which obviously are major sources of employment, are hoarding cash. This means that they are holding large amounts of cash on their balance sheets in lieu of spending on expansion and new employment. But of course they are: with personal credit in the shitter and falling wages, consumers will not be spending; in turn, big businesses have cut production; this means they have no reason to hire new workers or expand into new real estate.
Summary
Stagnant wages minus credit equals weak demand.
Stagnant Real Wages
Nominal wages are simply the dollar amount you bring home. Real wages are that amount compared to the prices of goods. Real wages matter, nominal wages do not. Since 1973, the real wage of the middle class has decreased. This raises serious questions. The most obvious question is why real wages have stagnated. But the most important question for this post is "how is it possible that real wages stagnated but our standards of living increased?"
Loose Credit
As wages stagnated, there was only one mathematically possible way to improve the standard of living of the middle class: loose credit. Politically, this was the only acceptable route. The fed is supposed to be politically independent, but decided that its job was to improve the standard of living of the American People rather than ensuring financial stability. Whoops!
With the collapse of the credit markets in 2008, we entered dangerous waters. Frozen credit combined with stagnant -in fact lower- levels of wages relative to 1973 puts the middle class in severe danger. Every single aspect of the American economy which relied on easy credit, such as retail, home buying, and construction, are now dependent on stimulus to keep them afloat. Why? Because without credit to prop up the economy, government spending must do the job. Infrastructure IE "shovel ready" projects are intended to fill in for construction. Tax credits prop up home sales. Tax cuts are intended to prop up retail.
Damage is being done not only to people and businesses that were on top of the credit bubble, but also to those that deserved to have good credit all along. Now, they can't get loans either because banks are risk averse. Banks are risk averse because there are still hundreds of billions, perhaps over a trillion, in toxic assets out there, and future uncertainty. So because of this, small businesses which pose nominal or moderate risk, and which should be the drivers of a recovery, cannot get the loans and investment needed to grow and hire more people.
Meanwhile, big businesses, which obviously are major sources of employment, are hoarding cash. This means that they are holding large amounts of cash on their balance sheets in lieu of spending on expansion and new employment. But of course they are: with personal credit in the shitter and falling wages, consumers will not be spending; in turn, big businesses have cut production; this means they have no reason to hire new workers or expand into new real estate.
Summary
Stagnant wages minus credit equals weak demand.
Austerity or stimulus, that is the question.
In case you haven't noticed, the biggest debate in the history of economics is occurring right before our eyes. The question is whether we should keep spending billions of dollars in stimulus to spur demand, business spending and investment or whether we should cut government spending to reduce the deficit, which now stands at 1.4 Trillion Dollars.
Background
The stakes couldn't be higher. Over 35% of people between the ages of 18 and 29 are without work. The unemployment rate overall is 9.5%, but this doesn't include so-called discouraged workers. If you include all discouraged workers, the real number is 21%, approaching great depression numbers. The volatility in stocks is a sign of further danger. Credit is still frozen, and state governments are facing serious revenue shortfalls. I will discuss some of the root causes of this situation in later posts.
Keynesian Economics
John Maynard Keynes was an economist (actually he was a mathematician but is remembered as an economist) who proposed that increasing government spending during a recession would spur domestic demand, in turn increasing business revenue, in turn increasing hiring. FDR accepted this theory and the increased government spending heading into WWII, which got us out of the depression, backs up the theory.
In 2009, congress passed $600B in stimulus spending. Now, the recovery is stalling due to several factors that I will discuss in other posts, and the administration is pushing for new stimulus. However, despite increasingly dire economic indicators, the political trend is against further stimulus spending.
The other side of the story
The federal budget deficit has risen to unsustainable levels. People fear that we will be "the next Greece." In case you didn't know, Greece's debt was downgraded several times in the Spring, prompting fears of sovereign debt defaults in Southern Europe and a potential collapse of the Euro system.
The primary argument on this side is that businesses are hoarding cash and not hiring, and consumers are afraid to spend, because everyone is afraid of US debt default at some future date. Some also argue that increasing government debt diverts private investment away from businesses and into government bonds.
Conclusion
The idea that people cut back spending due to government debt has no basis. People cut back spending due to their own debt, not government debt. Companies hoard cash and decline to hire because there is depressed demand. Continued stimulus, if correctly targeted, should spur demand and get businesses expanding again. If people are not spending due to fear of government debt, then it is irrational fear which is depressing demand. As FDR once said, "the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."
Background
The stakes couldn't be higher. Over 35% of people between the ages of 18 and 29 are without work. The unemployment rate overall is 9.5%, but this doesn't include so-called discouraged workers. If you include all discouraged workers, the real number is 21%, approaching great depression numbers. The volatility in stocks is a sign of further danger. Credit is still frozen, and state governments are facing serious revenue shortfalls. I will discuss some of the root causes of this situation in later posts.
Keynesian Economics
John Maynard Keynes was an economist (actually he was a mathematician but is remembered as an economist) who proposed that increasing government spending during a recession would spur domestic demand, in turn increasing business revenue, in turn increasing hiring. FDR accepted this theory and the increased government spending heading into WWII, which got us out of the depression, backs up the theory.
In 2009, congress passed $600B in stimulus spending. Now, the recovery is stalling due to several factors that I will discuss in other posts, and the administration is pushing for new stimulus. However, despite increasingly dire economic indicators, the political trend is against further stimulus spending.
The other side of the story
The federal budget deficit has risen to unsustainable levels. People fear that we will be "the next Greece." In case you didn't know, Greece's debt was downgraded several times in the Spring, prompting fears of sovereign debt defaults in Southern Europe and a potential collapse of the Euro system.
The primary argument on this side is that businesses are hoarding cash and not hiring, and consumers are afraid to spend, because everyone is afraid of US debt default at some future date. Some also argue that increasing government debt diverts private investment away from businesses and into government bonds.
Conclusion
The idea that people cut back spending due to government debt has no basis. People cut back spending due to their own debt, not government debt. Companies hoard cash and decline to hire because there is depressed demand. Continued stimulus, if correctly targeted, should spur demand and get businesses expanding again. If people are not spending due to fear of government debt, then it is irrational fear which is depressing demand. As FDR once said, "the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."
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