This document represents our team’s latest working draft of the Economic Situation. Please read it and identify errors and important omissions in the comments section below.
The economic situation in the U.S. as of May 2020 is the worst it’s been since 1929.
There are myriad causes–which have been developing for decades–and are now intensifying. We start with a list of what we believe to be the most important issues, and briefly discuss each in turn. After you’ve absorbed the material in this Situation 2020 report, let’s start a dialogue on the implications for our economic future, so we can develop a better set of alternatives.
Primary Forces Affecting Our Economy Today
- The Fed as Savior
- The United States of Debt
- Oligopoly and Oligarchy
- Dwindling Entrepreneurship
- Concentration of Wealth
- Covid-19 Pops the Everything Bubble
- Coming soon: The Fed as Savior 2.0 (MMT edition)
Automation is the use of technology, tools and processes to increase the productivity and profitability of business by increasing output per unit of labor. It needn’t be the case, but automation often reduces the amount of labor used in production, while (in theory) increasing the return to labor–i.e., the wage paid for that activity. Unfortunately, wages have not kept up with productivity growth in recent years, as companies have absorbed productivity gains into their profit margins. Many reasons have been given for this phenomenon, including the threat of job cuts via further automation, outsourcing aspects of production to lower-cost firms, relocation of factories abroad, and the breaking of unions. Automation doesn’t just eliminate rote work; with the advent of artificial intelligence, “knowledge economy” jobs are being eliminated as well.
Productivity has increased by an average of 2 percent per year since 1980. If we assume that all productivity gains result from the elimination of labor from production, the chart above illustrates the potential reduction in labor demand over the course of 26 years. At year 26 (i.e., 2006) we’d need half the number of workers relative to year 1 to produce the same quantity and quality of output. Put differently, we’d have to double output every 26 years in order to maintain full employment.
Even as productivity gains reduced the demand for skilled workers, the number of working-age Americans increased by 57% between 1980 and 2020.
According to the World Bank the global labor force increased from 2.3 to 3.4 billion people from 1990 through 2019. In today’s free-trade environment, that means the U.S. worker is now competing with 3.4 billion other workers. Initially, this affected employees involved in the production of tradable goods such as TVs, cars, ships, and monkey wrenches. Increasingly foreign workers are providing services such as legal research, interpretation of MRI scans, and financial models.
Most of those new workers live in countries with a relatively low standard of living, looser safety standards and lax environmental rules compared to the workers who live in the United States. Workers from these countries are perfectly delighted to get 10% of what an American worker would accept to do the same job. In a free-trade environment, the price of labor on a global basis tends to fall toward the lowest available wage, and the so-called “race to the bottom” begins.
Naturally, this puts enormous pressure on developed country wages, and it provides equally enormous incentives to move production from high-wage countries to low-wage countries. And that is exactly what happened, on an enormous scale, to American manufacturing. What Automation spared, Globalization decimated. That one-two punch severely degraded the American worker’s ability to sustain a middle class income. Many of those displaced from the industrial economy took lower-paying, less productive jobs in the services sector: restaurant workers, home health aides, personal service providers, etc.
As U.S. jobs were either automated or globalized away, the returns to workers (often measured as the share of labor in national income) declined steadily. Today, labor has almost no leverage, or “pricing power” in an automated and globalized economy. Real wages (incomes that are adjusted for the cost of living) have stagnated or declined for the majority of the U.S. workforce over the past three decades. This is is the root cause of our current economic malaise. As real household income falls, so does the demand for goods and services across the economy. Initially, families offset the income shortfall by borrowing, and many have received transfer payments from the government. These remedies helped households maintain their standard of living, but have become untenable given the escalation of debt burdens and depletion of savings needed for retirement.
The Fed as Savior
Throughout the 1980s, 1990s and 2000s, the world experienced an extended period of declining inflation as a consequence of automation and globalization. This is sometimes known as “good disinflation,” since prices fall (or rise more slowly) due to improving productivity. You can think of the decline in prices of personal computers–relative to their productive capacity–as the iconic example of good disinflation. This phenomenon is very different than the debt-deflation that occurred after the 1929 stock market crash, when a daisy chain of bankruptcies caused a collapse in demand, which led to falling prices.
The Federal Reserve might have interpreted the low inflation of this post-1980s era as a “good disinflation” were it not for Japan, whose economy cratered after the popping of its stock- and real estate market bubbles in 1989. Policymakers feared a repeat of what happened in the U.S. in 1929. Deflationary spirals are the one thing central banks fear most, and for good reason. They are the Black Death to an economy, and once they start, they are notoriously difficult to stop. Bankruptcy by one company undermines the creditworthiness of its partners; one employee laid off causes a decline in demand that undercuts the businesses he or she patronizes. Pretty soon economic activity grinds to a halt, and it’s vastly more difficult to restart that activity than it was to stop it. Central banks are terrified of deflation. That might explain why they have been throwing massive amounts of money into the economy at the earliest sign of financial market distress or rising unemployment.
Even if central banks were correct in their inflation diagnoses, there are limits on their ability to solve problems in the real economy. It’s very easy to create digital money – that’s just a few book-keeping entries. But it’s very difficult to get that money into the hands of people who will use it in ways that actually help the economy. Because the Fed represents a consortium of private banks, it does its work primarily through the banking system. Banks lend money based on the prospect of future interest payments and the return of principal. There are very few who will reliably lend money in a weak economy, and almost none who do so when a deflationary spiral looms.
Nevertheless, the Fed feels it must do something. When a crisis arrives, the central bank digitally creates money, which is used to buy newly-issued and existing debt instruments, such as US Treasury bonds and government-guranteed mortgage bonds. The central bank takes newly-issued Treasury bonds onto its balance sheet, and in exchange credits the government’s deposit account at the Fed. The Treasury is then free to spend the funds in all the ways government can dream up–which may or may not support the economy. Fed purchases of existing securities are done through the secondary market, from investors, banks and other financial institutions. The sellers may take the cash and hold it in reserve; they may lend it out or, alternatively, use it to purchase other financial assets.
This where the expression “monetizing the debt” comes from. The Fed creates digital currency and in so doing expands the money supply. Some of the money gets into the real economy via government spending and bank lending. However, government programs aren’t always productive–a great deal of the budget goes toward Social Security transfer payments, inflated health care spending (via Medicare and Medicaid), miltary ventures and interest on the debt. Nor are bank loans always productive; a significant portion of corporate borrowing in recent years has gone toward stock buybacks. These activities may or may not be beneficial to the recipients, but it’s hard to argue that they expand the productive capacity of the economy.
During each of the recent economic crises, from the 2000 Dot-Com Bubble, the 2008 Real Estate Bubble, and the latest Everything Bubble (2019)–compounded by the Covid-19 crisis–the Fed has swooped in to “rescue” the economy with low interest rates to drive ever more borrowing. Households and businesses are staggering under the burden of unpayable debts–and a near-total absence of “rainy day” funds. As a result, it’s taken progressively greater heroics from central banks to resuscitate the economy. They’re caught in the ultimate monetary Catch-22, having followed in Japan’s footsteps by creating the very debt-deflation they sought to avoid.
With the entry of China into the global economy, U.S. companies discovered that they could pack up their factories and ship them to Asia, fire their U.S. employees, and re-start production with vastly lower costs, all the while continuing to sell their products into rich U.S. consumer market. Profits skyrocketed. Egged on by consultants and activist shareholders, most large US firms jumped on the bandwagon.
As globalization and automation increased the leverage of corporations over their workers, the Federal Reserve’s easy-money policies provided the funds that busineses used to transform their operations and role in the economy. The classical view of finance is defined by its role in allocating capital to the the most productive business endeavors; profits are shared with employees and customers via the competitive operation of product and labor markets. That started to change with the re-conception of “shareholder value added” in the 1980s. Companies seek to establish dominant industry positions so as to use their market power to extract wealth from customers and employees. Regardless of the consequences for society, shareholders are prioritized over other stakeholders–and financial engineering gives them the tools to do so.
Around the same time, private equity firms such as KKR and Bain Capital invented the “leveraged buy-out”. Here’s how it works: you identify a company that has a strong credit rating and use its good standing to borrow huge sums of money in order to “buy out” the new equity investors. Some of the proceeds are invested into the company’s operations, and some are distributed to the investors as dividends or “management fees.” Sometimes the target companies benefit from this management, and sometimes the debt-laden husk of a company is simply sold for whatever can be had. This technique has gathered steam since 2000 as heavy hitters Blackstone and Carlyle copied the KKR/Bain model. Corporate leverage ratios skyrocketed, leaving companies ill prepared for recession, much less a crisis as serious as the one created by the coronavirus. Nevertheless, privately-funded mergers and acquisitions march on, now that “everything is private equity.”
Not only did the Federal Reserve’s low-interest rate policies offer ready financing for these transactions, they spurred a “reach for yield” into the most illiquid and risky corners of the financial market. In the early 2000s, banks and “shadow banks” (other financial intermediaries) learned that they could originate mortgages for people that weren’t credit-worthy, box up those questionable mortgages into a package, and stamp a phony “aggregate credit rating” onto that package–based on the dubious assumption that there would never be a national real estate slump. Those high-yielding AAA-rated bonds (an oxymoron if there ever was one!) were sold to unsuspecting investors who needed something to buy with all the liquidity floating around. These are just a few of the “innovations” that the financial industry developed in order to extract wealth from the rest of teh economy–until the wheels came off the wagon in 2008.
The problems of self-dealing and disguised risk became glaringly obvious with the Great Financial Crisis. And yet, after the commotion died down, little was done to change it. Not only are banks still “too big to fail,” they’re bigger than ever. Not a single financier was criminally prosecuted for the mortgage fiasco, even as millions of Americans lost their homes. Bailouts by the Fed of irresponsible and predatory industry leaders continues to this day, funneled through the financial system the very people and organizations that created the problem. Risk in the shadow banking sector has continued to escalate–but remains murky–as evidenced by the dramatic market turmoil of March 2020. Now we have Financialization on Steroids.
Having run out of ideas for generating earnings–which have stagnated since 2011–corporations took advantage of historically low interest rates to issue corporate debt, and use the proceeds to buy back their own stock. The reduction in share counts artificially boosts earnings per share, and tends to juice stock prices, thus rewarding corporate insiders with option-based compensation schemes. Meanwhile, as in the leveraged buy-out, companies are saddled with massive debts. If that weren’t bad enough (stock buybacks used to be illegal!) corporate executives raided their “rainy-day” funds in order to “return” cash to shareholders. Boeing is the poster child for irrational financial engineering; a once-great aircraft manufacturer and flagship American company, is now teetering on the edge of bankruptcy.
A fair-minded person would ask: “Is this a story of a few bad actors, or is this sort of self-destructive activity endemic to America’s major investors?” It’s looking increasingly as though the focus of corporate management has shifted away from creating great products and companies, and toward short-term share price appreciation. It makes one wonder if the entire investor class woke up one morning and decided to liquidate or otherwise extract all the wealth that was accumulated in our corporate infrastructure. Have investors given up on America? Do they know something the rest of us don’t?
The United States of Debt
We Americans have demonstrated a remarkable propensity to accumulate and abuse debt at all levels of our society. Households have relied on borrowing — from their paychecks, from their 401k plans, even from their home equity — in order to maintain an unaffordable standard of living. Corporations loaded up on debt to fund generous CEO compensation packages, stock buybacks, and dividend distributions. Governments issued debt to fund transfer payments across its citizenry, while letting our national infrastructure languish. In a way politicians mimicked the behavior of corporations; both groups took on debt as a way to move money around, rather than to build a more productive economy. Look in the mirror, fellow citizens, and take a bow.
We are awash in debt, and there’s no way we’re going to be able to pay it back. We’re dragging a very large boat anchor, and it’s wearing us down. The reason interest rates absolutely must stay low is simple: if they rise very much, that boat anchor will pull us under.
Who is buying our national debt? The traditional buyers were about evenly divided between domestic and foreign investors. Domestic buyers include retirement funds, corporations and Social Security. Foreign buyers are investors, corporations and central banks who use the dollar as a trading currency or as store of value. Lately, foreigners’ appetite for our debt has abated considerably. This is mostly a reflection of politics; we have alienated foreign partners with our trade war with China, and use of the SWIFT inter-bank settlement system as a tool of sanctions. China, Russia, Iran and other countries are increasingly determined to create an alternative mechanism for invoicing trade except the dollar. Here is a graph of U.S. National Debt ownership, by type of entity, over the past few decades. Notice how the share of debt held by foreigners has plateaued.
Declining Velocity of Money
Even as our debts have grown, they’ve become less productive; we’ve not allocated the funds in such a way as to generate income toward repayment. Hence, the ratio of US debt to GDP rises inexorably. Another way of looking at the same phenomeon is to compare the amount of money in circulation relative to our GDP. That statistic, known as “velocity,” measures the number of times money changes hands via purchase transactions. The bigger the money supply, and the greater its velocity, the more economic activity it supports.
As the chart below shows, the velocity of money in the U.S.–and in other contries–has been falling for the past two decades. You can bet that this chart bugs the Federal Reserve every time they look at it, and they look at it a lot. It’s quite apparent that monetary policy is not producing faster growth.
As noted above, a big part of the problem is that liquidity gets trapped in the financial system–and in the hands of the wealthy. What happens when rich people get all the money? They don’t spend much as compared with someone who really needs the income. They save most of their wealth, and that tends to immobilize our money.
In contrast, if a poor person got some extra cash, they’d run right out and spend it on all the things they need–and whatever else they’ve been missing all these years.
Another source of stagnation has been the decline in new business formation since the early 2000s. Here’s a chart that shows new businesses that were formed and then prospered enough to hire employees. Many explanations have been offered for this unfortunate trend, including an aging demographic, the burdens of regulation, rising business costs, and heavy student debt burdens among would-be entrepreneurs. Many firms that launch successfully are subsequently acquired, reducing the number of independent entities. Between mergers & acquisitions, business failures and stock buybacks, the number of US public companies has fallen by half since the late 1990s–to about 3,800 today.
What’s interesting is that there has been no shortage of new “firms” since the Great Recession ended. However, many of these are sole proprietorships in service to the so-called “gig economy” — each of which has a single employee beholden to one of the large platform monopolies. This isn’t what we think of when we talk about entrepreneurs.
Quote Freelancers now represent 35% of the total U.S. working population and could represent more than half of the nation’s workforce by 2027
Morgan Stanley Research. The Gig Economy Goes Global. 2018
Concentration of Wealth
The flip side of the reduction in the labor share is the rise in the capital share of national income. Capital, expressed as “embodied technology” in the form of machinery, software, production methods and the like are owned by the relative few. Workers use someone else’s technology to make products, and the worker doesn’t capture the full benefits of that technology. Every year, the fruits of technology – wealth – accumulate in fewer and fewer hands. A wealthy person eats about the same number of hamburgers, has the same number of kids and (typically) drives the same number of cars as a middle-class person. They might be better hamburgers, and have more rooms in the house, but their spending is not proportional to their wealth.
Quote A recent study by the Federal Reserve reveals the shocking extent of accelerating wealth inequality in America. Out of America’s total assets of $114 trillion owned by Americans in 2018, the wealthiest 10% of Americans owned 70% (up from 61% in 1989), while the bottom 50% of American households had virtually no net worth at all—down from 4% in 1989 to 1% in 2018.Steve Denning, senior columnist at Forbes. Read his excellent article here.
Concentration of wealth is a natural consequence of the uneven distribution of talent across the population. When it reaches the kind of extreme we now see in the U.S., that is an unnatural consequence of increasingly concentrated industry, financial power and political influence.
Oligopoly and Oligarchy
The US economy and financial markets are now characterized by extreme concentration of money and power, which has corrupted the operations of our government. The Supreme Court’s Citizens United ruling of 2010, which designated corporations as persons with a right to exercise “free speech” through their political contributions, opened the floodgates for improper influence of our elected officials. The problem didn’t start a decade ago, but it has become progressively worse, as large corporations have used their political leverage to seek merger approvals, favorable tax treatment, subsidies and regulatory forbearance in order to cement their monopolistic positions. As a result, we are now trapped in a self-reinforcing dynamic of financial and political domination by wealthy business and political elites.
The design of the CARES relief package illustrates the problem: about $1.5 trillion was directed toward households and small business, whereas ~$4.5 trillion was earmarked for the purchase of financial assets, in order to prop up markets. Since 86% of stocks are held by just 10% of the public, these donor-friendly measures intensified the growing problem of inequality in the U.S., even as hundreds of small businesses failed, and people lined up at food banks all around the country. Many of the businesses that benefited from asset purchases by “special purpose vehicles” were already on the bring of insolvency, having squandered their rainy day funds on stock buybacks.
Republicans say they will not consider additional aid unless and until Democrats agree to legislation that would relieve their big business donors of liability for failing to protect their employees from coronavirus–regardless of the extent or effectiveness of their efforts. They are also using the coronavirus as a pretext to call for cuts to already-low corporate tax rates, even though there’s no evidence that the 2017 cuts did anything to promote business hiring or capital spending. Democrats are hardly better; all signed on to a relief package that was tilted heavily toward big business and investors–with minimal accountability and no transparency. Their latest relief proposal has a provision to support for K-street lobbyists, who can hardly be considered an essential business!
Government Stimulus Spending
Government has the power–courtesy of the Fed–to spend money into existence. The government borrows the difference between what it spends and what it collects in tax revenue. During the 2008 real estate collapse and resulting Great Recession, the government spent a great deal of money into existence. A number of spending programs were instituted, including:
- TARP, which bought all those distressed “under water” mortgages no one else would buy. This effectively restarted the moribund mortgage origination mechanism, and made it possible to build and sell new homes. Housing is a huge component of GDP
- Cash For Clunkers, which bought up used cars in order to stimulate demand for new autos. The auto supply chain is another huge component of GDP
- Shovel-Ready Projects which dispensed money to states and local government for road improvements, and the
- Chrysler and GM bailouts.
Each of these programs was instituted in order to provide crucial demand for an economy whose private-sector spending suddenly decreased because of the Real Estate bubble popping.
This is an example of Keynesian stimulus. In 1936 during the Great Depresssion the famous British economist John Maynard Keynes declared that when all other sources of economic demand are paralyzed, it falls to the government to step in and support the economy. Once the economy is again functioning normally, the government is supposed to curtail spending as the private sector starts pulling its own weight. Since the 1990s our national policy has changed; the government continue spending even in good times, so it can’t be said that we’re actually embracing the spirit of Keynesian doctrine. We’re doing the spending part, but not the saving part.
During this latest Covid-19 crisis, the federal government allocated an unprecedented, staggering $2.4 trillion dollars to prop up the economy. One very important feature of this latest stimulus is that a significant portion of the money was simply given to individuals and small businesses to tide them over until this crisis abates. This indicates how dire the situation actually is. No one knows whether it’s enough, or how much permanant damage the coronavirus has been inflicted on the economy. How many $2.4 trillions can we spend of money we don’t have? With each successive convulsion it becomes more obvious that we won’t be able to repay what we’re borrowing from the future.
Covid-19 Pops the Everything Bubble
Unemployment has skyrocketed. A third of families run out of money for food each week. Bankruptcies are skyrocketing. There is a rising toll of death and despair. The Covid-19 epidemic would have hurt a healthy economy, but its effect on ours has been magnified by structural weaknesses that have been accumulating over the past 40 years. The long-running trends described above culminated in the Everything Bubble — our point of maximum vulnerability. Then came Covid-19, the pin that everyone knew would arrive, but no one knew when. Well, it’s finally here.
It could hardly have come at a worse time. Households are ill prepared; half have virtually no savings and are living paycheck to paycheck. 40% of US businesses could not survive a “normal” recession, per the IMF; about a quarter are already “zombies” whose earnings are less than their debt service. Government is up to its ears in debt, even as we allowed our educational system and physical infrastructure to deteriorate.
It’s hard to imagine how we let things get this bad in the span of two generations. One thing we know from centuries of recorded history is that humans are generally resistant to fundamental change until and unless the status quo becomes intolerable. Sadly, it’s much more difficult to achieve real change after the storm hits, the roof has collapsed, we’re standing in a pool of water, and the power lines are down.
The Federal Reserve and the US government will–in due course–do whatever they can to arrest the free-fall. As Winston Churchill said, you can count on Americans to do the right thing, once they’ve tried everything else. There is a real possibility that it won’t be enough; the solution must come from within our society–our families our neighbors, our businesses and our local insitutions. It’s time to start preparing and building a better way.
Contributors to this post include Tom Pfotzer and Karen Parker Feld.