On September 15, 2008 the trading firm Lehman Brothers declared bankruptcy. A small number of outstanding shares traded on the stock market that day. The SP500 lost almost 5% of its value. New Yorkers gathered in Times Square to watch the ticker tape display. A small number of people controlled the direction of the market and constructed a reality that they sold to the rest of us.
In politics, a few key people control
the direction and fate of legislation. In the Senate, the Majority Leader decides
whether to bring legislation up for a vote. Even if a bill makes it out of a
Senate committee, the Majority Leader can stop it from reaching the full
Senate. Unlike the Majority Leader in
the House, his position is practically impregnable. Legislation vetoed by the President
can be overridden by Congress. There is no recourse to a veto by the Senate
The current holder of the position
is Sen. Mitch McConnell from Kentucky. He is up again for re-election next year.
When Democrats held the Senate, Sen. Harry Reid ruled with a similar disregard
for others in his own party as well as the minority.
In 2014, 800,000 voters chose McConnell. In effect, less than 1% of the country’s voters control the course of legislation in the U.S. Did the founders of this country intend that one person should control Congress? James Madison, the chief crafter of the Constitution, worried that a majority would overwhelm and take advantage of a minority (Feldman, 2017). Accordingly, the Constitution is structured so that a minority controls power. However, one person is a very small minority. What would the founders think of the current arrangement in Congress? If Americans wanted a king with veto-proof power, America would still be a colony of Britain.
Our method of electing a President is a 230-year-old compromise between republicanism and democracy. An electoral college composed of men not subject to the passions of the crowd would elect the leader of the country. It was an Enlightenment model of dispassionate rationality.
Even if they had Fox News and CNN on Election night at the time of the founding, all the thirteen states were in the same Eastern time zone. At a recent symposium on our election, former RNC chair Michael Steele pointed out the west coast states are mostly taken out of the Presidential election (C-Span.org, 2019). By 5 P.M. Pacific time, they are discouraged from voting because much of the action has already been called. The founders did not design a system for four time zones.
We have 50 states but the election for President takes place in eight to twelve battleground states. Most polling is done at the national level, not in the battleground states. Many polls do not accurately survey the sentiments of the critical minority of voters in the states that will decide the election.
A minority of people own and control
much of the wealth of the world. They now pay a lower percentage of their
income than the bottom 50%. That includes federal, state and local taxes. In the
Triumph of Injustice, due to be released next week, authors Saez and Zucman
(2019) tally up the tax bills for the rich and ultra-rich. The book is #1 bestseller
at Amazon and it hasn’t been published yet.
In 1980, the top 1% paid 47% of their income in total taxes at all levels. Now they are down to 23% and below the rate paid by the bottom half of incomes. Two sets of rules – one set for the peasants and one for the castle royalty. The Constitution prohibits the granting of titles so the rich granted themselves the titles. This book is sure to get a lot of media attention. Like we need more controversy.
Feldman, N. (2017). Three Lives of James Madison: genius,
partisan, president. [Print]. New
York: Random House.
Two quick asides before I get into this week’s topic. A cricket perched on the top of a 7′ fence. It drew up to the edge of the top rail, learned forward, raised its rear legs as though to jump, then settled back. It did this twice more before jumping 8′ out then down into a soft landing on some ground cover. How far can crickets see, how often do they injure a leg if they land incorrectly and do they get afraid?
The bulk of the personal savings in this country is held by the top 20% of incomes, and it is this income group that received the lion’s share of the 2017 tax cuts. It’s OK to bash the rich but that top 20% probably includes our doctor and dentist. Before you start drilling or cutting me, I want to make it perfectly clear that I was not criticizing you, Doc.
In 2016, the top quintile – the top 20% – earned 2/3rds of the interest and dividend income (Note #1). Due to falling interest rates over the past three decades, real interest and dividend income has not changed. Real capital has doubled and yes, much of it went to those at the top, but the income from that capital has not changed. That is a huge cost – a hidden tax that gets little press. The real value of the public debt of the Federal Government has quadrupled since 1990, but it pays only 20% more in real interest than it did in 1990 (Note #2). Here’s a graph of personal interest and dividend income adjusted to constant 2012 dollars. Thirty years of flat.
Ok, now on to a story. Economists build mathematical models of an economy. I wanted to construct a story that builds an economy that gradually grows in complexity and maybe it would help clarify the relationships of money, institutions and people.
Let’s imagine a group of people who move into an isolated mining town abandoned several years earlier. The houses and infrastructure need some repairs but are serviceable and the community will be self-sufficient for now. The homeowners form an association to coordinate common needs.
The association needs to hire lawn, maintenance and bookkeeping services, and security guards to police the area and keep the owners safe. How does the association pay for the services? They assess each homeowner a monthly fee based on the size of the home. How do the homeowners pay the monthly fee? Each homeowner does some of the services needed. Some clean out the gutters, others fix the plumbing, some keep the books and some patrol the area at night. They work off the monthly fee.
How do they keep track of how much each homeowner has worked? The association keeps a ledger that records each owner’s fee and the amount worked off. The residents sometimes trade among themselves, but it is rare because barter requires a coincidence of wants, as economists call it. Mary, an owner, needs some wood for a project and Jack has some extra wood. They could trade but Mary doesn’t have anything that Jack wants. He tells Mary to go down to the association office and take some of her time worked off her ledger and credit it to Jack’s monthly fee. Mary does this and they are both happy (Note #3).
As other owners learn of this idea and start trading work credits, the association realizes it needs a new system. It prints little pieces of paper as a substitute for work credits and hands them out to owners who perform services for the association. These pieces of paper are called Money (Note #4).
money represents the association’s accounts receivable, the fees owed and
accruing to the association, and the pay that the association owes the owners
for the work they have done. Then the association notices that there are some
owners who are not doing as well as others. It assesses an extra fee each month
from those with larger homes and gives that money to needy homeowners. These are called transfers because the owners
who receive the money do not trade any real goods or services to the association.
In this case the association acts as a broker between two people. Let’s call
these passive transfers. We can lump these transfers together with exchanges of
goods and services.
some people from outside the area start stealing stuff from the homeowners. The
association needs to hire more security guards, but homeowners don’t want to
pay a special one-time assessment to pay for the extra guards.
of printing more Money, the association prints pieces of paper called Debt.
Homeowners who have saved some of their money can trade it in for Debt and the
association will pay them interest. Homeowners like that idea because Money
earns no interest and Debt does. The association uses the Money to pay for the
extra security guards.
there are not enough people who want to trade in their Money for Debt, so the
association prints more Money to pay the extra security guards.
Let’s pause our story here to reflect on what the words inflation and deflation mean. Inflation is an increase in overall prices in an economy; deflation is a decrease (Note #5). Inflation occurs when the supply of money fuels a demand for goods and services that is greater than the supply of goods and services. Ok, back to our story.
far so good. All the Money that the association has printed equals a trade or a
passive transfer. Let’s say that the association needs more security guards and
no one else wants to work as a security guard because they can make more Money
doing jobs for other homeowners. The association makes a rule called a Draft.
Homeowners of a certain age and sex who do not want to work as security guards
will be locked up in the storage room of the community center.
there’s a problem. Because the association has taken some homeowners out of the
customary work force, those people are not available for doing jobs for other
homeowners, who must pay more to contract services. This is one of several
paths that leads to inflation. To combat that, the association sets price
controls and limits the goods that homeowners can purchase. After a while, the
outsiders are driven off and the size of the security force returns to its
Now all the extra Money that the association printed to pay for the security force has to be destroyed. As homeowners pay their dues, the association retires some of the money and shrinks the Money supply. However, there is a time lag, and prices rise sharply (Note #6).
the ensuing decades, there are other emergencies – flooding after several days
of rain, a sinkhole that formed under one of the roadways, and a sewer system
that needed to be dug up and replaced. The association printed more Debt to cover
some of the costs, but it had to print more Money to pay for the balance of
repairs. Because the rise in the supply of Money was a trade for goods and
services, inflation remained tame.
didn’t seem to be any negatives to printing more Money, so the homeowners
passed a resolution requiring that the association print and pay Money to
homeowners who were down on their luck. These were active transfers – payments
to homeowners without a trade in goods and services and without some offsetting
payment by the other homeowners.
far in our story we have several elements that correspond with the real world: currency,
taxes, social insurance, the creation of money and debt and the need to pay for
defense and catastrophic events. Let’s continue the story.
the newly printed Money, those poorer homeowners could now buy more goods and
services. The increased demand caused prices to rise and all the homeowners
began to complain. Realizing their mistake, they voted on an austerity program
of higher homeowner fees and lower active transfers to poorer homeowners.
homeowners had to pay higher fees, they didn’t have enough extra Money to hire
other services. Some residents approached the association and offered to repair
fences and other maintenance jobs, but the association said no; it was on an
austerity program and cutting expenses. Some residents simply couldn’t pay
their fees and the problem grew. The association now found that it received
less Money than before the higher fees and Austerity program. It cut expenses
even more, but this only aggravated the problem.
the association ended their Austerity program. They printed more Money and hired
homeowners to make repairs. Several homeowners came up with a different idea.
There is another housing development called the Forners a few miles away. They
are poorer and produce some goods for a lower price. The homeowners can buy
stuff from the Forners and save money. There are three advantages to this
Things bought from the Forners are
Because the homeowners will not be
using local resources, there will be less upward pressure on prices.
The homeowners will pay the
association for the goods bought from the Forners and the association will pay
the Forners community with Debt, not Money. Since it is the creation of Money that
led to higher prices, this arrangement will help keep inflation stable.
the homeowners buy more and more stuff from the Forners, the money supply
remains stable or decreases. After several years, homeowners are buying too
much stuff from the Forners and there is less work available in the community.
As homeowners cannot find work, they again fall behind in paying their monthly
of those in the association realize that they don’t have enough Money to go
around in the community. There is a lot to do, and the homeowners draw up a
wish list: repairs to the roads and helping older homeowners with shopping or
repairs around their home are suggested first. A person who is out of work
offers to lead tours and explain the biology of trees for schoolchildren. The
common lot near the clubhouse could use some flowers, another homeowner
suggests. I could use a babysitter more often, one suggests, and everyone nods
in agreement. I could teach a personal finance class, a homeowner offers.
Another offers to read to homeowners with bad eyesight and be a walking
companion to those who want to get more exercise.
Everyone who contributes to the welfare of the community gets paid with Money that is created by the association. What should we call the program? One person suggests “The Paid Volunteer Program,” and some people like that. Another suggests, “The Job Guarantee Program” and everyone likes that name so that’s what they called it (Note #7).
far in this story we have two key elements of an organized society:
Money – a paper currency created by the
Debt – the amount the association owes
to homeowners (domestic) and the Forners (international).
week I hope to continue this story with a transition to a digital currency, banks
In 2016, the top 20% of incomes with more than $200K in income, earned more than 2/3rds of the total interest and dividends. IRS data, Table 1.4
In 2018 dollars, the publicly held debt of the Federal government was $4 trillion in 1990, and $16 trillion now. In 2018 dollars, interest expense was $500B in 1990, and is $600B now.
In David Graeber’s Debt: The First 5000 Years, there is no record of any early societies that had a barter system. They had a ledger or money system from the start.
In the Wealth of Nations, Adam Smith – the “father” of economics – defined money as that which has no other value than to be exchanged for a good. This essential characteristic makes money unique and differentiates paper money from other mediums of exchange like gold and silver.
An easy memory trick to distinguish inflation from deflation. INflation = Increase in prices. DEflation = DEcrease.
The account of the increased force of security guards – and its effect on prices and regulations – is the simple story of money and inflation during WW2 and the years immediately following. The process of rebalancing the money supply by the central bank is difficult. Monetary policy during the 1950s was a chief contributor to four recessions in less than 15 years following the war.
A Job Guarantee program is a key aspect of Modern Monetary Theory.
This past week, I found a July 2008 Wall St. Journal used as shelf liner. On the eve of 2018, a look back has some useful reminders for a casual investor.
Most of us remember the financial crisis that erupted in September 2008. What we may not remember is that the first half of that year was very volatile. In reporting about the first half, there were “warnings of the collapse of the global financial system.”
In the first six months of 2008, 703,000 jobs had been lost. The job losses continued until March of 2010 and totaled a staggering 8 million. In early July 2008, the stock market had lost 16% from its high mark in October 2007 but a balanced portfolio of 60% stocks and 40% bonds had lost only 8%. To prepare for a difficult second half of 2008, investors were cautioned to:
3) Spend less and invest more
4) Don’t pay high investment fees
5) Don’t get greedy and chase get rich investments
The advice is timeless.
In a holiday week, thousands of residents in coastal states lined up at their local tax assessor in order to pre-pay 2018 property taxes in 2017. Most of these residents have annual property taxes that exceed the $10,000 cap on all state and local taxes that can be deducted on 2018 Federal taxes.
The IRS said that they would not allow deductions for prepaid taxes unless the local district had assessed the tax by December 31, 2017. We may see lawsuits over the definition of the word “assess.” When is a homeowner assessed a property tax? When they receive a bill? When the district announces the rate for the following year?
In their battle against the IRS, Republicans have cut the agency’s funding so much that the IRS does not have the resources to perform audits on several hundred thousand to determine the status of assessment. The courts will likely weigh in on the question. Come next November, voters will register their opinions.
The New York Times featured a several question calculator to estimate the effect of the tax bill on your 2018 taxes.
Economists have noted the decades long decline in inflation-adjusted wages. Since 1973, the share of national income going to wages and salaries has declined by 14%.
Employee benefits as a percent of gross domestic income have grown by a third since the 1970s. Of course, a person cannot spend benefits.
Even after the increase in benefits, total income is down. In 1973, 50% of Gross Domestic Income (GDI) went to wages and salaries + 7.5% to benefits for a total of 57.5%. In 2016, 42% went to wages + 10% to benefits = 52%. Total compensation is down 10%.
As the wealth of the affluent continues to grow, the ratio of net wealth to disposable income has reached an all-time high.
It is inevitable that extreme imbalances must revert to mean. The last two peaks preceded severe asset repricings.
In any lively discussion of public education – its effectiveness, the spending and taxes required – some people bring out their swords, others their shields, and some are armed with both. Armed only with a crayon, I will examine some of these trends.
Let’s look first at higher education spending. The National Center for Education Statistics (NCES) at the U.S. Dept of Education reported that real – that is, inflation adjusted – spending per pupil had increased 233% in the past 31 years, an annual growth rate in real dollars of 2.8%.
NCES reports a slower spending growth in K-12 education – 185% in 28 years, or an annual growth rate of 2.2%.
But the annual growth rate during the past decade, 1999 – 2009, has slowed to just under 2%.
When we zoom in on the spending growth during the 1960s and 1970s, we see a real growth rate of 3.6%
What we see in the per pupil data is a gradual slowing down of the real growth rate of spending. Those who claim that there have been spending cuts in education have not looked at the data. There have been no cuts in real spending, only reductions in the rate of growth.
Some decry “austerity” policies recently undertaken in some European countries – the U.K. is an example – claiming that a country pursuing these policies has cut spending. When we look at the spending data, we find that there have been no decreases in real spending, only in the growth of spending. This misconception is common and results from a comparison of what we expect and what happens.
If we have usually received a wage or salary increase of 3% each year, we come to expect a 3% increase. If we get a 2% increase this year, it is 33% less than our expections and feels like a cut. A retiree who has become accustomed to an annual 8% return on her investments, may feel that she has lost money if her investments only gain 5% this year. It does no good to mention that she has really not lost anything.
Let’s get up in our hot air balloons and travel to California, where the size of its economy puts the state above many countries. California has often been the leading edge of trends that spread to the other states. Ed-Data reports that per pupil spending has flattened since the recession started in 2008. In real dollars, there has been NO GROWTH in per pupil spending in the past ten years.
Another complaint from teachers is that money is increasingly being spent on administrative costs, not teaching. In California, teachers still command the lion’s share of spending – more than 60%.
The proportion of teacher spending has remained relatively constant – above 60% – in the past ten years.
What has been growing? On a per pupil basis, “Services and Other Operating Expenses” have grown 4% per year, or 1.8% real annual growth, above the 2.2% annual growth in inflation. Administration expenses have grown at the same rate of inflation so that real growth has been flat. However, spending on teacher salaries has declined in real money at an annual rate of .7%. However, their benefits expenses have grown 1.4% annually in real dollars. Again, most people do not “feel” the cost of a benefit increase. The bottom line to most of us is what we bring home. It does not pay to tell a K-12 teacher that they are actually receiving a slight increase in real total compensation.
In California, as in many states, property taxes are a major component of revenues for K-12 education. Over the past nine years, revenues from property taxes for education have declined 3% annually in real money. For each student, there is $500 less money available from property taxes than it would have been if property tax revenues had kept up with inflation. As a percent of total revenue for K-12 education, property taxes make up a little over 60%.
In 2011-2012, property tax revenues essentially paid teacher salaries. Ten years ago, the percentage of revenues from property taxes was about 6% higher.
Other State revenues have had to make up for the shortfall in property taxes; the gap is about $1000 per student. The problem would be even worse if it were not for the slight decline in students for the past 8 years.
While California faces challenges from declining property tax revenues, what about the rest of the country? Let’s climb back in our data balloon and look at student enrollment throughout the country. The NCES reports the same slight decline in K-12 enrollment. However, they estimate a total 6% growth in K-12 enrollment in this decade.
As K-12 enrollment grew by a little more than 1 million in the 2000s, post secondary education enrollment grew by 6 million, or 37%, to over 21 million. (Source http://nces.ed.gov/fastfacts/display.asp?id=98). The growth rate in older students, those aged 25+ is even faster, rising 42%. In this decade, “NCES projects a rise of 11 percent in enrollments of students under 25, and a rise of 20 percent in enrollments of students 25 and over.”
The ratio of K-12 students to post-12 students was 28% in 2000; a decade later, it was 38%. While K-12 enrollment is projected to increase for the rest of the decade, post-12 enrollment is estimated to be much faster. How do these students pay for college? The most recent data from NCES is at the start of the recession; I would guess that the need for aid has grown mightily since then.
Put all of this in the blender: a declining work force (see my blog two weeks ago), a generational swelling of older people retiring, recovering but not robust state and local revenues, and more demand for K-12 AND post secondary education services. How will politicians react in the midst of so many competing demands for money?
The increasing pressures for money from different segments of the population puts us in the precarious position that we can not afford to go into a recession, an impossible situation since the normal business cycle includes a recession every 7 – 10 years. Europe is already in recession; China’s growth is still robust but slowing; on Friday, India announced a growth rate below 5%, the weakest in four years; in a hopeful sign, Brazil, the economic powerhouse of South America, is projecting GDP growth over 3%, rising up from an anemic 2.7% growth of the past 5 years. (World Bank source)
Slackening demand around the world presents challenges for the U.S. economy, problems that a spastic Congress will only worsen. Y’all be careful out there…