August 27, 2017

Pew Research surveyed four generations of Americans, from the oldest Americans who are part of the Silent Generation, those who grew up during the Great Depression, to the Millennials, those born between the years 1983 – 2002. Pew asked the respondents to list ten events (not their own) or trends that happened during their lifetime that had the most influence on the country. 9-11 was at the top of the list for all four generations. Obama’s election, the tech revolution and the Iraq/Afghanistan war were the other events common on each list. Some differences among the generations were understandable. Some were a surprise to me. The Great Recession/Financial Crisis of 2008 was only on the Millennials list. Many in this generation were in the early stages of their careers when the recession began. Here is a link to the survey results. Perhaps you would like to make your own list. Keep in mind that the events must have happened during your lifetime.

I don’t think that the Boomer generation understands the long-term impact of the Great Recession. In another decade, many will discover how vulnerable the financial crisis left all of us, not just the Millennials. As we’ll see below, the crisis may be over but the response to the crisis is ongoing.

One of the trends common to each generation’s list was the tech revolution, which has reshaped much of the economy just as the last tech revolution did in the 1920s. The widespread use of electricity, radio and telephone in that decade transformed almost every sector of the economy and accelerated the mass migration of the labor force from the farm to the city.

Like today, a small number of people made great fortunes. Like today, the top 1% of incomes accounted for about 15% of all income (Saez, Piketty). The GINI index, a statistical measure of inequality of any data set, has risen significantly since 1967 (Federal Reserve). The GINI index ranges from 0, perfect equality, to 1, perfect inequality. Incomes in the U.S. are more equal than South Africa, Columbia and Haiti (Wikipedia) but we are last among developed countries.

For several decades, Thomas Piketty and Emmanuel Saez have collected the aggregate income and tax data of developed countries. Piketty is the author of Capital in the Twenty-First Century (Capital), which I reviewed here.  A recent NY Times article referenced a report from Piketty and Saez comparing the growth of after-tax, inflation-adjusted incomes from 1946-1980 (gray line labeled 1980) and 1980-2014 (red line labeled 2014). I’ve marked up their graph a bit.

The authors calculated net incomes after taxes and transfers to determine the effect of tax and social policies on income distribution. Transfers include social welfare programs like Social Security, TANF, and unemployment. Census Bureau surveys of household income include pre-tax income and it is these surveys which form the basis for the calculation of the GINI index and other statistical measures of inequality.

I am guessing that Piketty and Saez used their database of IRS post-tax income data then adjusted for transfer income based on Census Bureau surveys. The Census Bureau notes that people underreport their incomes on these surveys.  Is the IRS data more reliable?  Probably, but people do hide income from the IRS. Both Piketty and the Census Bureau note that the data does not capture non-cash benefits like food stamps, housing subsidies, etc.

From 1947 to the early 1960s, the very rich paid income tax rates of 90% so that would seem to explain the after-tax income data from Piketty and Saez. The federal government took a lot of money from the very rich, paid off war debts, built highways, flew to the moon and built a big defense network to fight the Cold War.  Those infrastructure projects employed the working class at a wage that lifted them into the middle class. So that should be the end of the story. High taxes on the rich led to more equality of after-tax income.

But that doesn’t explain the pre-tax income data from the Census Bureau. The very rich simply made less money or they learned how to hide it because of the extremely high tax rates.  In the Bahamas and Caymans, there grew a powerful financial industry devoted to hiding income and wealth from the taxman. In the first years of his administration, President Kennedy, a Democrat, understood that the extremely high tax rates were hurting investment, incentives and economic growth.  He proposed lowering both individual and corporate rates but could not get his proposal through the Congress before he died.  Johnson did push it through a few months after Kennedy’s death. The rate on the top incomes fell from 91% to 70%, still rather high by today’s standards.

An important component of income growth in the post war period from 1947-1970 was the lack of competition from other developed countries who had to rebuild their industries following World War 2. These two decades were the first when the government began collecting a lot of data, and this unusual period then became the base for many political arguments. Liberal politicians like Bernie Sanders and Elizabeth Warren advocate policies that they promise will return us to the trends of that period. It is unlikely that any policies, no matter how dramatic, could accomplish that because the rest of the world is no longer recovering from a World War.

We could enact a network of social support policies that resemble those in Europe but could we get used to a 10% unemployment rate that is customary in France? For thirty years beginning in the early 1980s, even Germany, the powerhouse of the Eurozone, had an unemployment rate that exceeded 8%. At that rate, many Americans think the economy is broken. Despite 17 quarters of growth, unemployment in the Eurozone is still 9.1%. Half of unemployed workers in the Eurozone have been unemployed for more than a year. In America, that rate of long term unemployed is only 13% (WSJ paywall).

The post-war period was marked by high tax rates and high federal spending, a period of robust government fiscal policy.  The federal government intervenes in the economy via a second channel – the monetary policy conducted by the central bank.  The Federal Reserve lowers and raises interest rates, and adjusts the effective money supply by the purchase or sale of Treasury debt.

The 1940s, 1970s and 2000s were periods of high intervention in both fiscal and monetary policy. The FDR, Truman, Eisenhower, Johnson and Nixon administrations exerted much pressure on the Fed to help finance war campaigns and the Cold War. In 1977, the Congress ensured more independence to the Federal Reserve by setting two, and only two, clear objectives that were to guide the Fed’s monetary policy in the future: healthy employment and stable inflation.

A rough guide to the level of central bank intervention is the interest rate set by the Fed. When rates are less than inflation, the Fed is probably doing too much in response to some acute or protracted crisis.


Let’s look at an odd – or not – coincidence. I’ll turn to the total return from stocks to understand the effects of central bank policies. There are two components to total return: 1) price appreciation, and 2) dividends. When price appreciation is more than 50% of total return, economic growth and company profits are doing well. Future profit growth looks good and more money comes into the market and drives up prices. When dividends account for more than half of total return, as it did in the 1940s and 1970s, both GDP and company profit growth are weak. Both decades were marked by heavy central bank and government intervention in the economy.

Here’s a link to an article showing the total return on stocks by decade. During the 2000s, the total return from stocks was below zero. An average annual return of 1.5% from dividends could not offset an annual loss of 2.4% in price appreciation. Hubris and political pressure following 9-11 led Fed Chairman Alan Greenspan to make several ill-advised interest-rate moves in the early 2000s that helped fuel the housing boom and the ensuing financial crisis. His successor, Ben Bernanke, continued the policy of heavy intervention. Following the financial crisis, the Fed kept interest rates near zero for nine years and has only recently begun a program of gradually increasing its key interest rate.

The price gains of the 2010s have lifted the average annual return of the past 18 years to 7.4%, and the portion from dividends is exactly half of that, at 3.72% per year.  It has taken extraordinary monetary policy to rescue investors, to achieve balanced returns  that are about average from our stock investments.  Some investors are betting that the Fed will always come to the rescue of asset prices.  That same gamble pushed the country to the financial crisis when the government did not rescue Lehman Brothers in September 2008.

The financial crisis should have been on each generation’s list.  Within ten years it will be.  It is still crouched in the tall grass.



Happy days are here again.  Yes, girls and boys, it’s time to raise the debt ceiling!  By the end of September, the Treasury will run out of money to pay bills unless the debt ceiling is raised. This past week, President Trump hinted/threatened that he would not sign a debt increase bill unless it included money to build the wall between the U.S. and Mexico.

The Congress has not had a budget agreement in several years and is unlikely to enact one this year. People may sound tough on debt but a Pew Research study
showed that a majority do not want to cut government programs, including Medicaid.

Liberal economists insist that government debt levels don’t matter if the interest on the debt can be paid. This article from Pew Research shows the historically low rate on the federal debt. However, Moody’s reports that the U.S. government pays the highest interest as a percentage of revenue among developed countries. As a percent of GDP, we are 4th at 2.5%.

The Madness of Methodology

April 28th, 2013

A fight between economists is not as exciting as a dinosaur smackdown (Jurassic Park), but the controversy can be as damaging.  Politicians and pundits love to trot out those economic studies and theories which justify their actions or political point of view.  In 2009, two economists Carmen Reinhart and Kenneth Rogoff (now affectionately known as RR), published a study which showed that a country’s GDP growth becomes slightly negative when its debt grows above 90% of its GDP.  The study was cited by many politicians and pundits in Europe and the US, including VP candidate Paul Ryan, as they proposed various forms of austerity to curb the explosive growth of national debt.

Here’s what the debt to GDP ratio looked like 1940 – 1960

In the years 1947 – 1959, we had an annualized growth rate of 3.6% but a strong component of this growth was our strategic advantage in exports, being the manufacturing capital of the world after much of the production capacity of the developed world was destroyed in WW2.

Here’s what it looks like now; the same spike of debt.

But we have lost the advantage of being the leading manufacturer.

Given the assignment of replicating an existing economic study, Thomas Herndon, a PhD candidate at UMass, discovered some glaring spreadsheet errors in the original data set compiled by RR.  You can read an Alternet article summarizing the details here.

Some quick background.  There are two categories of economic policies.  Fiscal policy encompasses taxing and spending measures by a government.  Monetary policy is conducted by a country’s central bank and are targeted at the supply of money and interest rates.  Economists argue over which policy is more effective in a given circumstance.  Each of us goes about our daily lives under the influence of both fiscal and monetary policy. 

During the 1930s depression, the economist John Maynard Keynes proposed that governments borrow and spend money during recessions to make up for the lack of aggregate demand in the economy.  After the economy recovered, governments would then raise taxes to pay back the borrowed money.  Another leading economist, James Buchanan, predicted that nations who followed Keynes’ ideas would have permanent deficits.  While Keynes’ economic model was elegant, Buchanan argued that there was no incentive for a politician to raise taxes.

In 1963, with the publication of A Monetary History of the U.S., economists Milton Friedman and Anna Schwartz argued that the Depression had been largely a result of failed monetary policy by central banks.  During the 1970s, when government fiscal policies of increasing intervention in the economy failed to ingnite growth or curb inflation, Keynes’ policies fell into disfavor. 

The age old debate about the effectiveness of fiscal and monetary policy never dies. The recession that began in 2008 revived Keynes’ ideas.  In the late 1990s and early 2000s, economist Paul Krugman and Federal Reserve chairman Ben Bernanke were proponents of monetary solutions for Japan’s moribund economy.  As the world economy imploded in 2008, both men changed course and became advocates for fiscal policy as the most effective solution for the country’s economic woes.

In a recently published paper UMass professors Michael Ash and Robert Pollin (Herndon’s advisors), explained their methodology and took RR to task for their lack of follow up on incomplete data analysis after several years.  What they had missed was a follow up paper by RR in February 2011 and another published in the summer of 2012.  In these papers, RR modified their initial findings, saying that GDP growth slowed but did not necessarily turn negative.

In a WSJ blog post , RR answered the critique from the UMass Professors.  They admitted their spreadsheet error but reaffirmed their other assumptions in the study and their amended conclusions.

Paul Krugman weighed in (or waded in?), voicing his disappointment with RR’s methodology and their conclusion.  Krugman does make a point oft repeated in the social studies: correlation is not causation.  Does high debt cause slow GDP growth?  Or, does slow GDP growth cause high debt?  Or can we say that there is some indication that they accompany each other?

At Econbrowser, U. Cal professor James Hamilton, reviewed RR’s methodology and Ash and Pollin’s critique. (Link)  To which, Professors Ash and Pollin responded with some good points.

Ash and Pollin have made the original data available.  Some have accused RR of purposefully leaving five countries out of their data, saying that these five countries would have weakened or invalidated their findings.  The Excel file shows that this was a simple – but dumb – mistake, not some nefarious plan by RR.  The countries left out are on the last five worksheets which are arranged in alphabetical order.  What surprises many is that two prominent economists could publish a paper based on work that had so little verification before publication. 

What I question is RR’s decision to include many of the smaller countries at all in their analysis.  Finland and Ireland each have less than 2% of the GDP of the U.S. 

What I do hope is that this controversy will spur more analysis of the relationship between a nation’s debt load and its economic growth.  What I am afraid of is that this will discourage researchers from sharing their working data.  Reinhart and Rogoff are to be highly commended for doing so.

The Money Pot

On Dec. 1st, the bipartisan National Commission on Fiscal Responsibility and Reform (Debt Commission) will hold its sixth meeting to hammer out a series of proposals to reduce both the deficit and debt of this country.  Deficit refers to the current year’s budget imbalance, while debt is the sum of each year’s deficit.  You can watch previous meetings here.

Earlier in November the two co-chairs presented a draft proposal which distributes the pain of both budget cuts and higher taxes in an equitable fashion.  Of course, any constituency who suffers from the cuts or has to pay the higher taxes will not like a particular proposal – a NIMBY syndrome that has infected this country.

Why bother planning for the future?  Why not just wait till things get really bad and we have a Treasury Bond crisis, where other countries start selling their holdings of this country’s debt and the government has to pay high interest rates just to get anyone to buy the debt?  Ireland and Greece have tried that method and it has gotten ugly as each of those governments has had to make severe reductions in social security pensions and other benefits.  By planning ahead, we can make more gradual reductions but regardless of what we do, we will be reducing benefits and raising taxes.  Elected politicians of both parties have been making promises, and “bringing home the bacon” to their constituents for several decades.  They have done this by spending the social security taxes – essentially making it a flat tax for the general fund – that the large numbers of “boomers” have been paying in.  The boomers are nearing retirement age.

Here is the Congressional Budget Office (CBO) projection of this country’s debt and the effect of the Debt Commission’s proposals on the debt. (Click to enlarge in separate tab)

Here is a summary of the proposals, excluding any Social Security reforms.

As people are living longer, it makes sense to consider raising the full retirement age.  But this recent report by the Government Accountability Office (GAO) shows that such a seemingly simple solution has consequences that I had not considered.  They found that a quarter of the pre-retirement aged population had some work limiting condition and that two thirds of them work a physically demanding job.  The GAO thus anticipates a rise in disability, unemployment, food stamp, Medicaid and other benefit claims as this older population is unable to find work that they can reasonably perform.  The percentage of work restricted workers would only grow as we raise the retirement age.  The more sensible and fair solution is to reduce benefits and eliminate the early retirement option introduced in the 1960s.

When the Social Security system was enacted in the mid thirties, life expectancy for a 60 year old worker was 72.  (Bureau of Labor Statistics Monthly Labor Review, pg. 4)  In 2006, the Census Bureau estimated life expectancy for a 60 year old at 82, an additional ten years of life – and retirement benefits.

It is going to take character for many politicians to take on Social Security reform but it must be done if we are to get our financial house in order.  The last time the system was reformed was in 1983, when Democrats held a sizeable majority in the House and Republicans controlled the Senate.  The full retirement age was raised to 67 on a sliding scale and the payroll tax was increased.  Since then we have seen that increasing the payroll tax is but a flat tax, an excuse for our elected representatives to spend ever more money that they don’t have.  Any increase in payroll taxes would have to be accompanied by a complete divorce of the Social Security trust fund and the general revenue fund of this country. 

To hide the cost of the Vietnam war, President Johnson in the late sixties instituted the “unified budget” so the Federal government could take in payroll tax revenues, put them in the general fund, issue paper IOUs and spend the money on the war without arousing public anger.  Ever since, politicians have been hiding the size of real budget deficits.  Even when this country last had a “surplus” in the Clinton years, it was only a surplus because of the huge Social Security surplus.  The real budget ran a deficit.

Will we grow up, wake up and take some responsibility or will we continue to keep thrusting our hands into the Federal pot of money, trying to get as much as we can?  For too many years we have behaved as shoppers did last Friday morning at a Wal-Mart in Honolulu, pushing and shoving to get the best deal, then trying to take deals away from other people when there were no more to be had.

Debt Power

Visitors to an air show may have had the opportunity to witness the vertical take off power of an F18 fighter jet.  Flying horizontally to the ground, the jet makes an almost 90° turn and shoots up into the sky, a breathtaking show of power for spectators.  Welcome to the airshow of the last three decades.  Below is a Federal Reserve graph of household debt. (Click on any graph to enlarge)

  Aren’t you impressed with the sheer power of consumer borrowing?  Next in our air show is state and local government borrowing.

Not to be outdone, Fannie and Freddie, the government sponsored mortgage companies, show off their impressive borrowing power.

And lastly, our federal government turns on the after burners and shoots up into the debt stratosphere.  This chart does not include the almost $5 trillion of debt the federal government owes its agencies, like the Social Security trust funds, or the Federal Reserve.

Together, we – after all, it’s our governments – are the Blue Angels of debt – or perhaps we should be called the Red Angels of debt.  Together, we have piled up over $31 trillion in debt, more than twice the national GDP. 

Even if we devoted 10% of a $14 trillion GDP to paying down all this debt, it would take over twenty years.  As any one of us knows, debt is a serious drag on savings and investment.  We can expect that the drag of this debt will be with us for many years to come.