It’s the Wealth Transfers Stupid

In 1980, the top 1 percent controlled about 8 percent of U.S. national income. The bottom 50 percent shared about 18 percent. Today the top 1 percent share about 20 percent; the bottom 50 percent, just 12 percent.

But the problem isn’t that we have inequality. Some inequality is intrinsic to any high-functioning capitalist economy. The problem is that inequality is at historically high levels and getting worse every day. Our country is rapidly becoming less a capitalist society and more a feudal society. Unless our policies change dramatically, the middle class will disappear, and we will be back to late 18th-century France. Before the revolution.

And so I have a message for my fellow filthy rich, for all of us who live in our gated bubble worlds: Wake up, people. It won’t last.

If we don’t do something to fix the glaring inequities in this economy, the pitchforks are going to come for us. No society can sustain this kind of rising inequality. In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out. You show me a highly unequal society, and I will show you a police state. Or an uprising. There are no counterexamples. None. It’s not if, it’s when. – Nick Hanauer, “The Pitchforks Are Coming. . . For Us Plutocrats,” Politico Magazine, July/August, 2014 (here)

To begin, a word about my title: It alludes, of course, to James Carville’s famous slogan “It’s the economy stupid,” meant to remind Bill Clinton’s campaign workers that voters’ top concern is always their pocketbooks and the economy.  I’m not fond of that quotation, but I use it because it was recently paraphrased in connection with the principal subject of this post — The Crash of 2008.  The crash and its aftermath were addressed in a recent Op-ed by Paul Krugman entitled “Build We Won’t” (New York Times, July 3, 2014, here). Later, posting that Op-ed in Reader Supported News, editor Marc Ash changed the title to “It Was the Housing Bubble Stupid,” a seemingly innocent endorsement of the argument Krugman made about the Crash of 2008.

When it comes to the economy, I would not call any economist stupid, certainly not a Nobel Prize winner, and especially not Paul Krugman. Every economist has her or his customized framework, or model, of how the economy works, through which facts are filtered and interpreted. There is great variety in these perspectives, and it is not surprising that they have provided a number of  competing explanations for the causes and consequences of the Crash of 2008. It is a complex topic.

The brashness of Ash’s endorsement of Krugman’s Op-ed may have been invited by Krugman’s statement, in his opening paragraph, that:

The basic story of what went wrong is, in fact, almost absurdly simple: We had an immense housing bubble, and, when the bubble burst, it left a huge hole in spending. Everything else is footnotes. 

To accentuate that point, he added in his linked note: “This wasn’t hard or unconventional economics; it was not much beyond Econ 101.”

Ash knows that Krugman must try to explain economics to everyone. But this is not a topic that can properly be reduced to simplistic explanations. The problem is, many of us have never been satisfied with “conventional” explanations of why the bubble existed in the first place, and do not believe that everything else is footnotes. In “The Neoclassical Boondoggle and the ‘Mutilated Economy’,” Part 1 (November 15, 2013, here), Part 2 (November 16, 2013, here), and Part 3 (November 19, 2013here), I provided an in-depth review of Krugman’s conventional analysis of the aftermath of the Crash, which had been set forth, with alarm, in his discussion of the “mutilated economy,” and I find it helpful to review those posts again now. In Part 3, I argued that a far more straightforward explanation of what went wrong was “completely obscured” by “conventional” economics:

It is noteworthy that, nearly six years since the Crash of 2008, mainstream conventional economists meeting at an IMF conference on economic crises agonized over the completely unexpected failure of the U.S. economy to rebound. Even more telling is their growing suspicion that their supply-side perspective is missing an important part of the picture. Most importantly, it does not yet appear to have occurred to them to consider the implications of income and wealth redistribution.

Part 3 discussed Krugman’s analysis, in which he laid out the theory of a “new normal,” a theory which not only presumes the existence of a “normal” state but implies that a huge crisis like the Crash simply ratchets down, permanently, the “old normal.” Krugman pointed out that, up until just now, it has been considered “radical” to believe that the economy does not automatically adjust back to a vigorous full employment, however long it takes:

A number of economists have been flirting with such thoughts (here) for a while. And now they’ve moved into the mainstream. In fact, the case for “secular stagnation” — a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between — was made forcefully recently at the most ultrarespectable of venues, the I.M.F.’s big annual research conference. And the person making that case was none other than Larry Summers (here). Yes, that Larry Summers.

And if Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time. Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.

The elaborate theory of “secular stagnation” does in fact imply, as Krugman now puts it, that “when the bubble burst, it left a huge hole in spending,” and that “everything else is footnotes.” But in that discussion, he did not endorse the simplistic “conventional” theory he presents now; he did not deny that Summers might be right.   

The story of the Crash, however, is not as carved in stone as even Summers makes it seem: My perspective is that the rising concentration of wealth and incomes in the prior 30 years was largely responsible for the huge hole in spending, and that the collapse of housing prices can logically be regarded as a symptom of declining middle class wealth, and thus as a consequence of the ongoing, accelerating decline of bottom 99% wealth and incomes: The problem is inequality, not secular stagnation. 

Hanauer’s Perspective

This apparently has become Hanauer’s perspective too. Our current concern about the future of America’s economy arises after “neoclassical” macroeconomics, for more than a century, has failed accurately to perceive how market economies actually work. Hanauer perceives a clear connection between America’s high level of wealth inequality and its rapidly declining prosperity, and he asserts that we’re all in the same boat, so that he and his fellow “plutocrats,” in their own self-interest, need to stop the inequality growth and reverse the decline that is taking place beneath them.

But, you may ask, isn’t that obvious? Many of us believe that it is, and our numbers are growing. But that has not been obvious to neoclassical economics which has, over the last 150 years or so, treated inequality as irrelevant to growth and prosperity.  The review in my last three posts of Thomas Piketty’s new book “Capital in the Twenty-First Century” explains how the mainstream “supply-side” theories of growth have blunted our recognition of the true nature of market dynamics. Hanauer’s broad perspective is correct, I submit, but it raises questions Hanauer cannot answer: How serious has the inequality problem become in the United States? And how much time does the American economy have left before it succumbs to the collapse he senses is coming?

When I began working on inequality issues over three years ago, I was convinced that if such a pessimistic assessment is truly valid, it would be politically necessary to convince billionaires like Hanauer that their own interests are indelibly linked to those of everyone else beneath them. The publication of Joseph Stiglitz’s book “The Price of Inequality” in 2012, and the release of Robert Reich’s movie “Inequality for All” in early 2014, have helped raise awareness of the contours of the inequality problem, although these two have not been able to answer the second of these two questions. 

That question is not easy to answer, because income and wealth are interconnected in both directions: Wealth produces incomes (returns and profits) and high-end income produces wealth (savings and hoarding). In the first instance, income concentration is determined by institutional factors (market power, taxation, etc.) as well as by the degree of wealth concentration, but as wealth continues to concentrate, the additional returns it produces become a growing contributor to income inequality, accelerating the growth of both income and wealth inequality. 

Robert Reich has, no doubt, influenced many in the top 0.1% with his recent Aspen Lecture (July 3, 201 4, video here). The last question posed to him in the Q&A at the end of that lecture was a big one: What is more important, income or wealth inequality? Reich responded that, despite Piketty’s overall emphasis on wealth inequality, income inequality seems more important in the U.S. today; This is not surprising, for Piketty’s own discussion of the U.S. problem was based on income inequality in the U.S., and his treatment of wealth as “capital” made wealth accumulation in the U.S. seem to be a relatively innocuous long-run problem, as my previous posts explained. Notably, Hanauer stresses wealth inequality as the main concern: Is Reich correct that, for the U.S. economy, income inequality is the primary concern? 

Wealth concentration in the United States, which has gotten far less attention here than income inequality has, I believe, reached dangerously high levels. The concentration of reported net worth has been rising exponentially. That does not diminish the importance of Reich’s emphasis on the debilitating effects of income inequality, which alone is sufficient cause for concern. Reich points out that the (former) middle class has now exhausted the three “coping mechanisms” for dealing with falling median real household income: (1) increased female workforce participation (1980s-1990s); (2) Increased hours worked (1990s); and (3) “Turning our homes into piggy banks,” i.e., borrowing on our home equity. Consumer demand is 70% of the U.S. economy, he says, and that demand continues to decline with declining median incomes. With the coping mechanisms used up, declining demand must accelerate.

Despite the lack of formal economic theoretical support, many wealthy Americans could see what the bursting real estate “bubble” entailed, and began to share Hanauer’s concerns. In 2010, a group calling themselves “The Patriotic Millionaires” (here) began to press for increased taxes on their incomes, stressing the importance to them of a viable economy. Other billionaires, such as Warren Buffett and Bill Gates, spoke out on social and moral concerns and taxation. The majority of the top 0.1% and the top 0.01%, however, apparently remain unconvinced that inequality poses a serious economic problem for them, or a threat to their fortunes. And neoclassical economics continues to be a major impediment to understanding how serious the problem has become or how rapidly it is undermining our society and our democracy.

The Mainstream Perspective

Neoclassical economics, in fact, could not imagine that any collapse will take place, ever, because of its slavish belief in an overall full employment “equilibrium” toward which market economies are always driving. Unfortunately, the equilibrium was never more than a hypothetical state, but as neoclassical theories have been taught over and over again for decades, hypothetical notions have become presumptive. A few contemporary economists, including James Galbraith and Mason Gaffney, have pointed out that most economists simply believe as a matter of faith in an automatic return to full-employment equilibrium. Paul Mattick explains this problem nicely in his 2012 book Business as Usual: The Economic Crisis and the Failure of Capitalism (Reaktion Books, Kindle Edition, pp. 17-18):

In the later nineteenth century the ‘classical’ political economy of Smith, Ricardo, and their followers was replaced by a new ‘neoclassical’ mode of theorizing that was in many ways quite different. It emphasized not, like classical theory, the division of income among social classes, but the decision-making of individuals. Borrowing the concept of ‘equilibrium’ from physics, along with the mathematics of static mechanics, the new economics continued to insist that capitalism by its nature tended to settle in a stable state in which each individual is maximally satisfied, given the constraints set by his or her relations to the rest of the system. (How this idea was to be reconciled with the equally basic dogma that capitalism tends to grow as a wealth-producing system was left for future thinkers to resolve.) From this point of view too, therefore, breakdowns of the market system, as opposed to imbalances in particular markets, are out of the question; what general difficulties do occur must be the effects of some non-economic factor, such as the weather, human psychology or mistaken government policies.

I opined in my last post that macroeconomics was likely led astray from the beginning by the development of theory, over the centuries, from a “supply-side” perspective. Krugman has consistently condemned its extreme formulation, namely, the so-called “trickle-down” fantasy designed to counter proposed taxation of the wealthy and corporations (“Charlatans, Cranks, and Kansas,” The New York Times, June 30, 2014, here). As Krugman’s report on the “mutilated economy” last November shows, moreover, faith in “supply-side” reasoning may now be loosening its grip on fundamental mainstream economics as well. 

And, as Krugman also discussed (with disgust) in this Friday’s Op-ed (“Who Wants a Depression,” The New York Times, July 11, 2014, here) economics is intensely political:

One unhappy lesson we’ve learned in recent years is that economics is a far more political subject than we liked to imagine. Well, duh, you may say. But, before the financial crisis, many economists — even, to some extent, yours truly — believed that there was a fairly broad professional consensus on some important issues.

This was especially true of monetary policy. It’s not that many years since the administration of George W. Bush declared that one lesson from the 2001 recession and the recovery that followed was that “aggressive monetary policy can make a recession shorter and milder.” Surely, then, we’d have a bipartisan consensus in favor of even more aggressive monetary policy to fight the far worse slump of 2007 to 2009. Right?

Well, no. I’ve written a number of times about the phenomenon of “sadomonetarism,” the constant demand that the Federal Reserve and other central banks stop trying to boost employment and raise interest rates instead, regardless of circumstances. I’ve suggested that the persistence of this phenomenon has a lot to do with ideology, which, in turn, has a lot to do with class interests. And I still think that’s true.

He goes on to explain that while lowering interest rates are supposed to spur investment and growth, wealthy people get higher returns when interest rates are high, so their wealth increases faster. The greater the share of top incomes that consists of returns on wealth, the more this factor can potentially influence monetary policy, and accordingly the greater effect monetary policy can have on inequality and depression. 

Market Optimism, and the Bubble Phenomenon

Meanwhile, the growth of income and wealth concentration naturally promotes rosy and impressionistic financial analyses. Take, for example, the most recent Fisher Investments “Stock Market Outlook, 2014: Part 2” (April, 2014, here). From the report’s Executive Summary:

The bull market turned five during the quarter, prompting many to question how much longer stocks can keep climbing.  (Appendix I) While bull markets can die for many reasons, age, magnitude and gravity aren’t among them. Unless a bull is truncated early by a sweeping, under-appreciated negative force (we can’t identify any such large, stealthy forces on the horizon currently), it will typically run on until sentiment becomes euphoric to the point reality can’t possibly live up to investors’ expectations.

This isn’t the case today. While sentiment has improved somewhat in recent months, a cloud of skepticism remains. Fear of heights, jitters over geopolitical tensions in Eastern Europe and anxiety over future Fed moves have helped keep expectations low. Investors broadly still don’t appreciate how favorable the current landscape is. (Appendix III) Even as final data showed the U.S. economy grew 2.6% in Q4 2013, with corporate profits and business investment hitting new all-time highs, folks fretted growing cash stockpiles and rising stock buybacks as signs businesses aren’t “investing in the future,” robbing the economy of future growth opportunities. (p. 1)

In his e-mail distributing this report, Forbes columnist Ken Fisher asked: “Could this bull market be a bubble in disguise?”, a question the report promised to address. The report progresses thus:

A bull market is like a vector: It will keep running until it loses steam or hits a wall – fundamental negative big enough to put a dent in the global economy that surprises markets. We don’t see any walls within the next 12-18 months. * * * Nor does the bull appear likely to run out of steam in the foreseeable future. Economic and corporate conditions typically exceed  investors’ expectations through most of a bull market — a powerful force pushing stock prices even higher. This bull market has been no exception. It’s no secret US and global economic growth have been lackluster, but even slow growth has exceeded dour “new normal” growth expectations, and fears of global economic doom have proven unfounded. (pp. 6-7). 

The report adds: “Price-to-earnings ratios have been rising, an expected feature of maturing bull markets.” (p. 21) 

In case investors are worried about record stock prices in the face of “lackluster” growth, the report continues:

Lastly, the notion that this bull market is reserved from “reality” is a perception problem. There is no greater reality in equity markets than corporate profitability. As we detailed in Appendix III, profits are high and rising, underpinned by increasing sales. The global economy seems poised to continue growing — an excellent backdrop for continued profit growth ahead. (p. 22)

But might this long bull market just be “a bubble in disguise”?

Bubble fears aren’t likely to exist when a true bubble does — their existence signals still-prevalent skepticism. Bubbles are events of mass psychology: When inflated, few folks fear a bursting bubble. Headlines tend to proclaim the arrival of a virtuous new economy — “it’s different this time” — as they have throughout history. That sentiment seems far removed from today.

Growing wealth inequality reflects the availability of more money to invest, and that bids up equity market prices, but there is necessarily declining wealth below, and a reduction of earnings support for the rising stock prices. Thus, bubbles today are much more than events of mass psychology. They have monetary antecedents and consequences. Similarly, high price-earnings ratios today in U.S. stock markets are much more than just reflections of bull market optimism, and “lackluster” earning and consumption growth in the U.S., together with record corporate profits and corporate earnings, indicates that corporations are collecting substantial amounts of economic rent.

Fisher Investments simply overlooks the growing concentration of wealth and income in America, the factor that ensures the continuing record-setting pace of American securities markets in the face of bottom 99% stagnation. It is irrelevant for America that “fears of global economic doom have proven unfounded”: The U.S. economy has by far the highest inequality among wealthy nations, and whatever happens to the rest of the world, Hanauer’s fears of a collapsing U.S. economy are not unrealistic. 

Importantly, Ken Fisher is one billionaire who seems unlikely to be swayed by Hanauer’s appeal anytime soon.  His firm may be influential enough to influence other plutocrats as well. So we need to keep reminding them, “It’s the wealth transfers stupid.”

Boom or Bubble?

The only sensible answer to Fisher’s question — “boom or bubble?” — seems to be that so long as wealth continues to concentrate at the top, bubbles and crashes are inevitable. Consider the recent view of Neil Irwin (“Welcome to the Everything Boom, or Maybe the Everything Bubble,” Investor Outlook, The Upshot, The New York Times, July 7, 2014, here):

Welcome to the Everything Boom — and, quite possibly, the Everything Bubble. Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors.

The phenomenon is rooted in two interrelated forces. Worldwide, more money is piling into savings than businesses believe they can use to make productive investments. At the same time, the world’s major central banks have been on a six-year campaign of holding down interest rates and creating more money from thin air to try to stimulate stronger growth in the wake of the financial crisis.

This is more ominous than it might at first blush appear. Rising investment prices likely translate, in fairly short order, into rising consumer prices. This is not the classical image of inflation driving up prices because of an excess of consumer demand, which as Reich has observed has been depressed because of rising inequality. Such inequality-driven inflation can only hasten the development of an “everything bubble.”     

About the Crash

Hanauer’s identification of wealth inequality as the incipient cause of decline and potential depression is confirmed by all of this. There is no reasonable basis for expecting a continuing level of “secular stagnation,” for there is no reason to expect no further bubbles and crashes, as wealth continues to concentrate. My computations show an increase in reported top 1% net worth of between 1980 and 2008 of $18 trillion, in 2010  dollars. (See “Inequality and the National Debt,” April 9, 2014, here.) This figure, which does not include estimates of off-shore wealth owned by Americans, amounts to an average top 1% wealth increase of more than $600 billion/year. Since the economy was growing over this period, in the years just before the Crash the amount was greater than this average. Although this much money could not have come directly from bottom 99% wealth, the amounts coming from money created “from thin air” to which Irwin refers impact the bottom 99% through additional inflation, reducing the real value of the bottom 99%’s remaining wealth and incomes. 

Now the significance of the exhaustion of Reich’s three “coping mechanisms” for the bottom 99% looms large. The last of the three, in which houses were converted into “piggy banks” as people borrowed on their equity to obtain needed cash, was in effect a final act of desperation: for the vast majority of wealth holders beneath the top 1%, their primary marketable asset is their homes. Reich has, in fact, accurately described the process through which declining median income facilitates transfers of wealth to the top. The “housing bubble” was a big one:

The U.S. lost $3.4 trillion in real estate wealth from July 2008 to March 2009 according to the Federal Reserve. This is roughly $30,300 per U.S. household (Pew Charitable Trusts, April 28, 2010, here).

Because it does not consider wealth transfers, “conventional” economics misses the essential nature of decline and depression. The conventional view is that the Crash blasted a hole in the economy that merely created a “new normal” of lower growth, and “secular stagnation.” The numbers prove otherwise, however. The Crash of 2008, the subsequent chronic long-term unemployment, the foreclosure epidemic and the sharp decline in median incomes, together with the record gains in stock prices and, indeed, investment prices generally, all tell a different story. It is the story of the enormous power of income and wealth concentration to bring a market economy to its knees.

Two things are occurring now that suggest the U.S. economy is approaching the brink of Great Depression II: (1) The middle and lower classes are running extremely low on collateral to secure the loans they need to meet everyday living expenses; and (2) The federal government has exhausted its ability to finance, with fiscal expansion, the continuing rapacity of profits at the top.


What the supply-side perspective has missed by ignoring inequality altogether is the major role that income and wealth redistribution plays in decline and depression. In fact, inequality growth has proven to be, by far, the most significant determinant of stagnation and declining growth.  So, yes, above all else: “It’s the wealth transfers stupid.” 

JMH – 7/13/2014  

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