The Change of the Change

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March 20, 2022

by Stephen Stofka

Why do unexpected price changes bother us so much? Prices reflect two forces central to our lives – time and utility. Both are common measures yet each is uniquely experienced. The price of our utility – what we need and enjoy – and the price of our time is deeply personal. Price surprises upset a finely balanced mechanism inside each of us. We can adapt to a one-time price change. We struggle to make sense of repeated and erratic price changes.

A proverb in the tool business is that customers don’t want a ¼” drill bit – they want a ¼” hole. The price of goods we buy is the price of the experience we get when we consume a good. We don’t want an ice cream – we want the pleasure of eating ice cream. The cost of ice cream is the price of our time enjoying it.

Interest is the price of money’s time the way that wages are the price of our time. Einstein once quipped that interest was the most powerful force in the universe. We compliment ourselves when we enjoy an unexpected bonus return on our savings. We are outraged when the power of interest works against us. A credit card debt or student loan debt may grow even though we are making regular payments.

The price of money’s time and the price of our time are like two riders on a seesaw who seek an approximate level. For two decades the Federal Reserve has sat on the interest rate side of the seesaw to keep them close to the ground. In response, the prices of consumption assets (houses) and productive assets (stocks) have risen high. What about the price of consumption goods?

Inflation measures changes in the price of consumption goods the way that our car’s speedometer – the mileage indicator – measures our change in position on the road. We adapt to constant speed or inflation. What we notice then are the changes in speed or inflation – the acceleration. After a decade of low inflation, the pandemic was like approaching a highway junction and coming to a near stop before having to accelerate onto another highway. In mid-2021, the sudden acceleration of price changes seemed normal, a catching up after the economic lockdowns of 2020. The acceleration has continued for months now, as though the gas pedal got stuck. Using the FRED data tool at the Federal Reserve, I have charted the price acceleration – the change of inflation.

Today’s price acceleration is as high as that of the deep recession in 1973-74. Two shocks – one of them short term, one long term – produced a singular phenomenon economists called stagflation. The short term shocks were two oil crises in 1974 and 1979 that decreased world oil production (Gross, 2019). The long term shock was the large influx of the Boomer generation into the labor force, doubling the 1% average growth of the labor force. Forty years ago, the Boomers were in their late 20s and early 30s – at that age when we have increasing incomes and material needs. Lopsided demographics and supply shocks combined to produce erratic price changes.

To bring price acceleration under control in 1979 Fed Chair Paul Volker kept raising interest rates (FEDFUNDS) to keep them above the inflation rate. Interest rates acted as a cap on price changes. Once these two forces balanced, the change in inflation decreased but there was a cost. At that time, small businesses paid 20% interest for unsecured short term loans to cover payroll and accounts receivable. The change in interest rates was swift enough and large enough to drive the economy into recession. Until the 2008-9 financial crisis, the 1981-82 recession was the worst since the Great Depression of the 1930s.

This week, Fed Chair Jerome Powell announced a series of small and steady interest rate hikes with a target that is far below the interest rates of four decades ago when a 10% mortgage rate was a bargain. The demographics are different today. Because the labor force is barely growing structural price pressures should weaken. The large Boomer generation is aging and old people don’t buy as much stuff. The Fed can let the interest rate side of the seesaw rise up a bit and hope that inflation will lower in response. Instead of having to cap price changes as they did four decades ago, they can work to a negotiation between these two price forces.

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Photo by Miles Loewen on Unsplash

Gross, S. (2019, March 5). What Iran’s 1979 revolution meant for US and Global Oil Markets. Brookings. Retrieved March 18, 2022, from https://www.brookings.edu/blog/order-from-chaos/2019/03/05/what-irans-1979-revolution-meant-for-us-and-global-oil-markets/

Price Connections

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March 13, 2022

by Stephen Stofka

As I was waiting for the car to drink its fill at the gas station, I got to thinking about prices. Their role is to convey information about resource availability but prices are not a conversant sort. They grunt monosyllabic phrases, relaying only the information that something has changed. A person who paid not the slightest attention to the news would wonder what happened when they filled up their car.

When prices decrease, do we buy more of a good or service? Sometimes. We usually pay attention to prices when they increase. In response, we substitute a cheaper good if we can, smoothing out the price changes. Most of us don’t drive more when gas prices decrease. Annual miles driven per adult have fallen as the large Boomer generation has aged (FRED Series TRFVOLUSM227NFWA/CNP16OV). The oldest of the Boomers passed 55 in the mid-2000s when per capita miles peaked.

Prices may not change as quickly as global conditions. When there is a poor coffee harvest in Brazil, the price of coffee in the grocery store may take several months to respond. Not so with gasoline, a global commodity so vital to the global economic engine that gas prices respond quickly to geopolitical events.

Many countries subsidize or control the price of some goods but too much control and prices no longer relay information between producers and consumers. The U.S. government subsidizes the farmers who grow corn to make the ethanol blended into gasoline. It subsidizes dairy, peanut and cotton farmers. Countries with state owned industries may keep a lid on prices to gain and keep political power. This year Kazakhstan lifted price caps on liquified petroleum gas which most people use to fuel their vehicles. Thousands of citizens protested (Neuman, 2022). In 18th century France, people rioted over the price of bread. Gasoline is today’s bread.

The ancient Greek philosopher Protagoras said that man was the measure of all things. In past centuries, essential food commodities that kept people alive were a yardstick of value. Anyone who has to drive to work or drives for a living feels that way about the price of gasoline. Larger firms that depend on predictable prices use the futures market to smooth gas prices but an independent Uber driver bears the full impact of rising gas prices. Should the U.S. subsidize gas prices for those who depend on the fuel? Those policies, politically popular in countries like Venezuela and Kazakhstan, foster political corruption and weaken the economic system. Why? One group of taxpayers subsidizes another group of taxpayers. The price of gasoline is closely linked with the price of power.

Competitive pricing is a hallmark of capitalism but such pricing minimizes profits. Large companies prefer to set a price which maximizes their profits within a competitive environment where other large firms use the same strategy. The result is an entire aisle in a grocery store filled with breakfast cereals that are priced at 10 times their cost. With the milk subsidies, the cereal becomes more affordable. Developed countries have learned to tame the prices of essential items without keeping those prices in a cage. We want our prices to communicate essential resource allocation information but we want well-behaved prices.

In our modern global economy we have many more goods and services available to us. Multiple sources of food products help lower prices but we are subject to the geopolitical risks of a global economy. The Covid pandemic and the war in Ukraine has reminded us that risks accompany benefits. The Russian people are beginning to experience the isolation of being cut off from the international system of trade, money and assets. Like prices, it is better when we are connected to each other.

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Photo by Clint Adair on Unsplash

Neuman, S. (2022, January 8). There’s chaos in Kazakhstan. here’s what you need to know. NPR. Retrieved March 12, 2022, from https://www.npr.org/2022/01/08/1071198056/theres-chaos-in-kazakhstan-heres-what-you-need-to-know

The Fruits of Labor

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March 6, 2022

by Stephen Stofka

In trips to the grocery store and gas station, many of us develop an inflation calculator that we trust because it tracks price changes in the unique basket of goods that we buy. If the price of mushrooms doubles, we only care if we buy mushrooms. Economists have the difficult task of computing the price changes of a common set of goods. They spend an extraordinary amount of time and expense surveying people in cities throughout the U.S. to construct a representative sample of the goods we buy (BLS, 2021). The price weighting that economists use to measure inflation differs from our instinctive approach. We assign weighting by the frequency we do something. What catches our attention gets more weight in our consumption basket.

Our sense of inflation can be guided by the price of gasoline when we fill up each week, but it is only 4% of the CPI measure of inflation (BLS, 2022). Many of us underweight the cost of housing that we provide to ourselves. Wait, what? In January, economists at the Bureau of Labor Statistics computed a 4% increase in housing costs even for those who owned their home outright. They call this Owners’ Equivalent Rent (OER) and it makes up a whopping 25% of the calculation of inflation. In the BLS methodology, homeowners are both landlords and renters. Actual rental increases made up only 7% of the index but the BLS uses those rent increases to compute the market price of what a homeowner could rent out their home for each month. For a homeowner, that 4% increase in housing costs is actually a 4% saving. Even better, homeowners do not pay income taxes on that imputed income.

Like gasoline, we overweight the effect of grocery prices because we frequently shop. If we enjoy a sirloin steak once a week, we notice when it increases in price from less than $10 to $13 a pound (FRED series APU0400703613). In the years after the financial crisis many households ate more ground beef. Prices doubled in response to the increased demand (APU000070312). Ground beef is what economists call a Giffen good. Unlike normal goods, we buy more of a Giffen good when our income goes down.

Many of us measure inflation by comparing the prices we pay to the wages we receive. Workers have gained little in the past two decades, eking out an extra 8% in real earnings over that time. All of that gain has come in the past eight years. Workers should expect to share in the productivity increases of the past two decades.

An assumption of neoclassical economics is that workers’ wages reflect their marginal productivity. A BLS analysis (Sprague, 2014) of labor productivity showed an average gain of 2.2% in real output per hour from 2000-2013, yet workers’ real earnings declined slightly. In the past eight years, annual productivity gains have averaged about 1%, slightly below the annual 1.2% increase in real wages. Why have workers been able to command wages appropriate to their productivity in the past eight years but not in the 14 years prior? The problem began before the financial crisis when productivity rose 2.7% per year and real wage growth actually declined. The 2000s came after a period of reversal for the owners of capital. During the 1990s, much money was lost in the pursuit of profits promised by the developing internet. Owners and management recaptured those losses by keeping the productivity gains to themselves during the 2000s. Workers may not be able to regain those lost wages but at least they are securing the fruits of their labor.

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BLS. (2021, December 9). Consumer price index frequently asked questions. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/cpi/questions-and-answers.htm

BLS. (2022, February 10). Table 1. Consumer price index for all urban consumers (CPI-U): U. S. city average, by Expenditure Category – 2022 M01 results. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/news.release/cpi.t01.htm

Sprague, S. (2014, May). Definition, concepts, and uses. U.S. Bureau of Labor Statistics. Retrieved March 5, 2022, from https://www.bls.gov/opub/btn/volume-3/what-can-labor-productivity-tell-us-about-the-us-economy.htm

A Real Test

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February 27, 2022

by Stephen Stofka

A central archetype of the American character is an individual who stands up to a large institution. America declared independence in defiance of the British Empire. The text and spirit of the Constitution shows a healthy distrust of institutional power. In Mr. Smith Goes to Washington, Jimmy Stewart played an idealistic young man who wrestled with the power politics of the Washington elite. In 1971, Daniel Ellsberg challenged the White House and Defense Dept when he released the details of the Pentagon Papers to the New York Times. In his 2016 Presidential campaign, Donald Trump played the newcomer, ready to challenge the institutional power of Washington. This week thousands of Ukrainian civilians volunteered to take up arms against the Russian Army’s assault on their capital, Kyiv. This was a defiant defense of democracy that most Americans could champion.

Americans have long been conflicted in their attitudes to the institutions that form the web of civic life. Our faith in government has been sorely tested in the past two decades. The pretext for the war in Iraq was founded on faulty intelligence and political passion. The fall of Enron and the discrediting of a large accounting firm, Arthur Anderson, led many to question what the attention and motives of the many agencies that took up office space in Washington. The financial crisis confirmed our worst fears. Corruption, incompetence and political impotence had helped bring the global financial system to its knees. When the pandemic touched the shores of America in early 2020, there was not much belief left in the reservoir of American trust.  

In late 2018, the Pew Research Center interviewed 10,000 Americans about their trust in government (Rainie et al., 2021). Trust in government was at historic lows and ¾ of respondents thought it had become much worse in the past twenty years. A supermajority of Americans can’t distinguish truth from lies when politicians speak. At that time, only 42% of those interviewed thought that a lack of trust was a big problem. The pandemic has revealed just how big a problem it is. Parents have threatened school board officials. Thousands of airline passengers have threatened fellow passengers and airline employees. Americans have reacted violently not to an invading army but to mask mandates. Is this what we fight for?

A lack of trust in government may be very low but it is not new. More troubling is the growing lack of trust we have in other Americans, an unraveling of social cohesion that takes years to develop and decades to repair. Under the pretense of fostering connection with others, social media helps drive us apart with carefully written algorithms that promote conflict as a form of social engagement. We need an enemy other than our neighbors. As Ukrainians escape with their children to Poland, Slovakia, Hungary and Moldova – as they sleep in subway tunnels to escape bombardment by Russian troops – as they take up arms to protect their capital – let’s remember that the real test of freedom is not whether we have to wear a mask in a grocery store or on a plane.

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Rainie, L., Keeter, S., & Perrin, A. (2021, July 27). Trust and Distrust in America. Pew Research Center – U.S. Politics & Policy. Retrieved February 27, 2022, from https://www.pewresearch.org/politics/2019/07/22/trust-and-distrust-in-america/

Good Hands Government

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January 20, 2022

by Stephen Stofka

Socialist policymaking is founded on an aspirational principle of equal outcomes. Central to that approach is an expanded role for government as an insurance company, the insurer of last resort. Should government be the insurer of first resort? Some would prefer that but others are uncomfortable with the lack of privacy that entails. A characteristic of insurance is what economists call asymmetry of information. The insured knows more about their situation and risks than the insurer. Do we want to give government an incentive to pry into our private lives? Can government protection create a moral hazard? Will people be less careful or less industrious because they trust that government has their back? Student loan debt brings a pointed focus to some of these issues.

According to 39 state Attorney Generals, Navient was a predatory servicer of high-interest loans for students attending for-profit colleges (Settlement Administrator, 2022). In the mid-2010s, the Obama administration put its foot down with many  for-profits – if they could not meet minimum graduation rates, they would be cut off from federal funds. Many folded. Recently, 39 states  reached a settlement with Navient that gave relief to many thousands of student borrowers. Who was given no relief? Students who had been paying their loans on time.

In many areas of our lives, we disagree about who is responsible for the risks of unwelcome outcomes. A person who gets an education assumes a certain risk that higher lifetime earnings will be greater than the cost of an education. Such a risk cannot be quantified or insurance companies would sell policies to college students. However, the federal government provides some guarantee for federal student loans. Colleges, including for-profit schools, are usually accredited. That accreditation provides some assurance – but not insurance – to a student that a school’s curriculum has sufficient quality to earn the accreditation. However, conventional non-profit colleges are supervised by regional accrediting organizations that have higher standards than the accrediting bodies of for-profit colleges (The Best Schools, 2022). Without the regional accreditation, for-profit students often discover that they cannot transfer their credits to a 2-year or 4-year college. Employers may doubt the worth of their educational credentials.

Is this a case of buyer beware? How is a college education different than starting a small business? Students have a wealth of research available to them before they enroll in a for-profit college. Should taxpayers pick up the tab for students who may not have done adequate research before committing to a student loan?  Every year hundreds of thousands of small businesses go out of business for the same reason. They did not research the market. They didn’t have adequate management experience. Many people may be stuck with 2nd mortgages used to fund the business. Should taxpayers bail out small business owners? 

Financial and medical risks can be substantial and we may vehemently disagree about government’s responsibility for absorbing these risks. Government now insures us against loss of income due to injury (workmen’s compensation) or permanent inability to work (disability insurance), old age (Social Security), protects our pension funds (ERISA), insures our homes against flooding (Flood Insurance Program). It pays our medical bills if we are poor (Medicaid) and when we are old (Medicare).

Should government have a minimal or expanded role in our lives? If we want government to have our back, what is the limit? What are the boundaries between government and our lives? What is the extent of our personal responsibility? How much risk must we shoulder? There are many strong opinions on the subject.

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Settlement Administrator. (2022, January 13). 39 State Attorneys General Announce $1.85 Billion Settlement with Student Loan Servicer Navient. Home. Retrieved February 20, 2022, from https://navientagsettlement.com/Home/portalid/0

The Best Schools. (2022, January 6). Guide to for-profit colleges: What you need to know. TheBestSchools.org. Retrieved February 19, 2022, from https://thebestschools.org/resources/for-profit-colleges/

Unfolding Story

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February 13, 2022

by Stephen Stofka

Trying to find the cause of inflation is like looking for a car in a big parking lot. Science is a process of ruling out causes. The latest release of the Employment Cost Index (ECIWAG) from the BLS rules out higher wages and salaries as a key driver of rising prices. During the financial crisis wages fell below trend and have stayed below the trendline for 12 years until this past year.

The average pay increase this past year has been 4.0%. Workers who have gained the most in this past year have been those with lower wages. Customer facing workers in leisure and hospitality workers are up 8% and retail workers have gained 6.3%. Other service jobs and whole sales are up over 5%. Industries with the lowest increases are in education 2.5%, state and local government (2.5%), utilities 3.0%, and financial activities 3.2%.

Two times a year the Philadelphia Federal Reserve (2022) surveys a number of economic forecasters and publishes the consensus outlook for inflation over the next decade. The current projection is 2.5%. Expectations for inflation among the public are on a shorter time frame. Once a month the University of Michigan publishes their survey of customer inflation expectations. December’s reading was 4.8%.

Housing costs could be a culprit for rising prices. The vacancy rate is very low at 5.6% and that has helped support a 5.7% increase in housing costs (CPIHOSSL). The growth rate has been swift in the past year, an aftereffect of the pandemic. For several years, the growth rate of housing costs had been about 2.7%, then fell to 2% during the pandemic. This erratic growth of the past months is unlikely to last.

The lack of new car inventory has led to sharp increases in used car prices, with smaller cars leading the pack. When the pandemic hit, auto manufacturers canceled their orders for semiconductors. As the tech factories in Asia resumed production, the auto manufacturers dedicated what chips they could get to larger SUVs and trucks with the highest profit margins. That has left a severe shortage of smaller cars. That has resulted in sharply higher prices for the used models.

The pandemic has been an experiment that would be unethical if done by anyone other than mother nature. For decades economists will try to understand the interlocking price and supply mechanisms. Economists still argue about the causes of the stagflation of the 1970s, almost fifty years ago. Human society and our interactions are at least as complex as the human mind. As economists sort through the dynamics of evolving relationships they can only hope to understand what is not true.

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Federal Reserve. (2022). First quarter 2022 survey of professional forecasters. Federal Reserve Bank of Philadelphia. Retrieved February 13, 2022, from https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q1-2022

A Voting Booth

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February 6, 2022

By Stephen Stofka

How important are energy prices? British homeowners are paying almost 60% more than last January’s prices to heat their homes with natural gas (https://tradingeconomics.com/commodity/uk-natural-gas). They are upset at government officials and the party in power. In the U.S., the annual January increase to residential consumers was only 2.6% (https://www.eia.gov/dnav/ng/hist/n3010us3m.htm). The UK imports most of their natural gas while US consumers enjoy the benefits of US gas reserves. Americans drive far more than Brits so the weathervane of popular sentiment  in the US is the movement of gasoline prices. In general people don’t like rising prices – period – but when gasoline prices rise faster than paychecks, the public has the sense that something is broken and they want government to fix it. A gas pump can be a voting booth.

During the eight years of slow recovery following the financial crisis in 2008, paychecks struggled to keep up with the rise in gasoline prices. Income growth finally rose above gasoline price growth in the middle of 2016. As incoming Presidents do, Mr. Trump took credit for some of the gains and policies of his predecessor. Until the pandemic struck, paycheck growth stayed above the growth in gasoline prices. These annual growth rates erase most of the seasonality of gasoline prices, which fall in the winter and rise in the spring when the refineries must switch to a more expensive blend for the heat of summer.

That trend took a “wheelie” in the spring of 2020 when the entire country responded to the swell of pandemic deaths in New York City. Headed by a soapbox President with little organizational skill, the Trump administration struggled to cope with the daily demands of the pandemic. Mr. Trump himself cared little for the research his staff brought him. He has admitted that he is not a reader, trusting his instincts more than information. Had he shown more consistency during this singular pandemic, he might have retained enough college educated male voters to tip the 2020 election in his favor. As with many of us, Mr. Trump cannot come to grips with his own failings so he blames others. He has turned that nasty habit of self-deception into an art form of grand deception.

As the chart shows, the annual growth in gasoline prices was far above the growth in paychecks when Mr. Biden took office in the beginning of 2021. Both growth rates reached 10% in the 3rd quarter of last year, but people pay more attention to the sticker price on the pump as they fill up their cars. In the fourth quarter, paycheck growth edged up while gasoline prices growth edged down, a heartening trend if it continues.

Presidents have little effect on gasoline prices, a global commodity dependent on supply and demand around the world and subject to geopolitical tensions. However, the public holds Presidents responsible. If gasoline prices are high, reporters at White House press briefings ask what the administration is going to do about it. Occasionally, they release some of the government’s strategic gasoline reserves to show some action. That release has only a small effect on global prices but it shows the administration’s attention and good intentions. Until the country went off the gold standard during the Depression, each President had to answer for movements in the price of gold. Gasoline powers our daily lives. It is our daily gold.

Mr. Biden is mindful of the electoral beating that Mr. Obama took in the 2010 elections when the Tea Party led a Republican movement to forcefully take the majority gavel from the House Democrats. Most Presidents suffer election losses in the midterms but it was a devastating turnaround in a census year. Mr. Obama was more skilled at rhetoric than taking the tiller of a national political party. As a politician with decades of experience, Mr. Biden is already in campaign mode, moving funds to battleground states to get out the vote in November. He will be mindful of the public’s sensitivity in the final months leading up to the midterms.

Gasoline prices are higher in the summer months and people drive more so they notice high prices. The press is quick to point out Mr. Biden’s low approval ratings, currently in the low 40s. Mr. Biden’s low was Mr. Trump’s high. In a country evenly split between Democrats, Republicans and Independents, a President will struggle to gain and hold a majority favorable public opinion above 50%. According to Gallup (https://news.gallup.com/poll/116500/presidential-approval-ratings-george-bush.aspx) George Bush did not enjoy a majority opinion after 2005, his first year of his second-term. His ratings fell near 30%, lower than Mr. Trump’s lowest ratings. When did those lows come? During the summer months of 2008 when gasoline prices rose above $4 per gallon. Voters carried their sticker shock at the pump into the voting booth a few months later and gave Democrats a resounding majority.

If gasoline prices are moderate this summer, that will give a boost to Democratic chances at the polls but Mr. Biden should be savvy enough not to count on that. He must assume that prices will not be friendly to him or his party this summer. The Republican strategy is to use pocketbook issues to regain a majority in both the House and Senate. Their divisive stance on moral issues only antagonizes Independent voters in the suburbs so Republicans must focus on practical issues. Midterm elections suffer from low turnout. Voters shrug. The party that can energize their voters can command the political field for the next two years. Gasoline prices energize voters.

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The Leaving

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January 30, 2022

by Stephen Stofka

Every week I read about the Great Resignation. What is it? The number of people quitting their jobs is at a historic high. In the leisure and hospitality industry, the number of quits is up 20% from pre-pandemic levels. In retail jobs, quits are up 16%. People quit their jobs for a lot of reasons. In more normal times, a higher quit rate indicates a greater confidence in finding another job. As the quits rate goes up, the unemployment rate goes down. I’ve inverted the unemployment rate to show the historic trend between job quits and unemployment.

These are not normal times. Employees in public facing jobs are enduring abuse from patrons. We have lost a social cohesion, an agreement on the rules of civility. In response to physical threats to employees over mask wearing, Denver’s Children’s Museum closed for ten days. According to the FAA, the number of active investigations into unruly passengers climbed 7-fold in 2021. The number of quits in healthcare field, in the leisure and hospitality industry, education, and food services are all more than 1/3 higher than pre-pandemic levels. In professional services, quits have increased by 28%. In the retail sector, the growth is only 18%.

In the South and Midwest regions that the Labor Department surveys, the quits rate has climbed 30%. According to US Census data almost 40% of the country lives in the Southern region and is the fastest growing region of the country. The Midwest region has about half the population, has recently experienced a slight population decline, but is experiencing the same job churn. Are people moving from the Midwest to the South? In the Western and Northeastern regions, the quits rate has grown more modestly – at 20-22%.

The first estimate of last quarter’s real GDP growth was an annualized 5.5% growth (GDPC1). That’s real growth after subtracting the effect of inflation. Household purchasing grew by a strong 7.1% after inflation (PCEC96). How much have households borrowed to fund that buying spree? 3rd quarter real debt rose by only 2.5%, easing slightly after the first two quarters of last year (CMDEBT/PCEPI). We won’t have 4th quarter debt levels until early March but real debt levels are still below the peak of 2007 when households had gorged on debt. Until the financial crisis in 2008, real household debt was growing 7-8% per year then went negative for six years after the crisis. Household debt did not rise above a 1% growth rate until the final year of the Obama presidency.

Households have a historically low debt burden as a percent of disposable income (TDSP). If a household’s monthly income after taxes is $1000, the average debt payment is less than $100, near a four decade low. There is a lot of guesswork in this series but the important thing is the declining trend in the data. People are not borrowing beyond their means as they did during the 2000s. Do lower debt levels mean that buying pressures will remain strong? Will another Covid variant further strain hospital staff and resources?

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A Good Decade

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January 23, 2022

by Stephen Stofka

As a year-end review I’ll compare risk and returns of the past ten years with the decade before. I submitted several standard portfolios to Portfolio Visualizer. These portfolio metrics are based on broad indexes with a yearly rebalancing. These are broad benchmarks and the performance metrics don’t include fees, taxes and transactions costs that would reduce an investor’s actual returns.

The CAGR is the compounded annual return. Worst Year measures the worry level that an investor might face. The first portfolio might be termed aggressive but would be typical for a person who is more than ten years from retirement. The 60/30/10 is a moderate portfolio allocation and the 50/40/10 is a balanced weighting, more appropriate for those who might need to draw funds from the portfolio.

2012-2021                                           2002-2011                            

Stocks/Bonds/CashCAGRWorst YearCAGRWorst Year
70/25/512.2%-3.6%4.6%-24.6%
60/30/1010.7%-3.0%4.7%-20.6%
50/40/109.4%-2.5%4.9%-16.3%

The last decade stands in stark contrast to its predecessor, which included the great financial crisis of 2008-2009. The 7.5% difference in annual returns between the two decades was worth $106K extra return on a $100K portfolio. The more aggressive 70/25/5 portfolio gained an additional 1.5% during the past “good” decade but had only a .1% lower return during the previous “bad” decade. During that bad decade, however, the aggressive portfolio lost 25% of its value in one year. A 20% drop in value is considered a bear market. For investors with no need to sell any of their portfolio, those were “paper” losses. Some investors needed to tap their portfolio for living expenses in retirement or to recover from job loss. During the recovery from the financial crisis, some older investors continued to work past retirement age to replenish their portfolio. Many of them left the labor force when the pandemic struck. The number of workers over 55 is still 1.2 million less than it was at the onset of the pandemic (FRED Series LNS12024230).

The government learned valuable lessons from its response to the financial crisis in 2008-9. Both the fiscal and monetary response had been too moderate and that prolonged the recovery over many years. When the pandemic struck in March 2020, Congress and the Federal Reserve enacted strong relief measures that protected many families and some businesses from the economic fallout of pandemic restrictions. Occasionally, Congress can come together on a bipartisan basis and accomplish something.

It is unlikely that the 2020s will have the same high returns as the last decade. A younger investor can take a more aggressive stance and rely on the law of averages. Time is on their side. An investor who may need funds from their portfolio in the coming years might check their allocation and rebalance to a more appropriate level of risk.

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Wealth-Income Ratio

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January 16, 2022

by Stephen Stofka

Analyses of wealth and income inequality engage policymakers and economists and provoke lively discussion on social media. Thomas Piketty (2013) stirred up debate with the publication of Capital in the Twenty-First Century. Five years later came the publication of After Piketty (Boushey et al., 2019), a series of essays by prominent economists. I wanted to tackle a different aspect of this subject – why the ratio of wealth to income has become so erratic in the past two decades. The answers are too complex for a blog post and beyond my capability to understand. But let’s take a short journey down the rabbit hole.

In the past ten years both stocks and housing prices have more than doubled, moving in a synchronized dance. In the graph below I’ve plotted the two series on top of each other to show the similarity in trend.

The Federal Reserve charts a ratio of household wealth to disposable income, which is income less taxes plus transfer payments like Social Security. Although there are some similar components, the ratio is different than the capital-income ratio that Piketty uses. Housing represents the majority of wealth for many households. Many workers own part of the stock market through mutual funds, 401K plans at work or IRA retirement plans. The doubling of these two asset classes has led to a rise in household wealth and raised the wealth-income ratio to historically elevated levels.

In the graph above I have highlighted past decades where this percentage found a level and remained there. For almost 50 years following WW2 household wealth was about 5x disposable income. Beginning in the mid-90s, this percentage turned erratic, unable to find any stability until the violent recession following the fiscal crisis. In 2013, stock prices and housing began a steady climb that endured the pandemic shock and continues to this day. Will we establish a new level of wealth at 8x disposable income in the next few years? I doubt it. Such a growth curve is unsustainable.

As I search for the underlying causes, I look back to the mid-90s when the wealth-income ratio first turned erratic. The internet first began to grow into our commercial and personal lives. Heady expectations of rocketing business profits led many investors to make wild bets on companies who had little history, a lot of hype and little profit. Out of the carnage of mis-investment emerged an internet platform that has transformed our personal lives. Apple and Amazon are two success stories. In 1997 giant Microsoft made a $150 million investment in failing Apple Computer that kept Apple out of bankruptcy. This year Apple’s valuation passed the $3 trillion mark, about 13% of the entire GDP of the U.S. That same year Amazon went public. It’s business model? Selling books. For years it struggled to make a profit. Amazon’s market capitalization is now over $1.6 trillion. The so called FAANG stocks of big tech have surpassed the industrial and financial giants of the 20th century. Two researchers at Morningstar studied the decade long impact of the ten largest stocks and the impact they made on the overall return of the entire stock market (Solberg & Lauricella, 2021). Perhaps that concentration of market power is contributing to a more erratic wealth-income ratio.

Low interest rates and leverage have affected household wealth. In the mid-90s, bankers at JP Morgan developed the collateralized mortgage to spread risk. In ten years, misuse and overuse of that idea led to a historic meltdown in housing prices and caused a worldwide fiscal crisis. Since then the supply of new housing has not kept pace with demand. Fueling that demand is a large Millennial generation which is settling down. Persistently low mortgage rates have increased the pool of qualifying buyers. Low rates have raised the present value of the future housing services a homeowner receives from the house they buy. Not enough supply to meet demand has led to higher housing prices.

High inflation this year has grabbed headlines and stirred up comparisons to the stagflation of the 1970s. There are too many differences between now and then but that is a subject for another blog post. A rising federal debt has certainly contributed to a rising level of wealth but does not account for the erratic behavior of the ratio itself. In the mid-90s, the federal debt began falling and the wealth-income ratio rose dramatically.

I suspect that finding an equilibrium in this ratio will be a painful process. To reestablish a sustainable ratio, there are two possibilities. The first is a hard landing where asset valuations fall more than incomes fall. The second scenario is a soft landing in which incomes rise more than valuations rise. Let’s hope for the soft landing.

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Photo by Ludde Lorentz on Unsplash

Boushey, H., Bradford, D. L. J., & Steinbaum, M. (2019). After Piketty: The agenda for economics and inequality. Harvard University Press.

Cautero, R. M. (2021, December 28). What is disposable income? The Balance. Retrieved January 15, 2022, from https://www.thebalance.com/what-is-disposable-income-4156858

Piketty, T. (2013). Capital in the Twenty-First Century. (A. Goldhammer, Trans.). The Belknap Press of Harvard University Press.

Solberg, L., & Lauricella, T. (2021, December 1). The FAANG Market is Fading. Morningstar, Inc. Retrieved January 15, 2022, from https://www.morningstar.com/articles/1070180/the-faang-market-is-fading