SERIOUS MONEY:RUSSIAN-AMERICAN author Ayn Rand championed the morality of rational self-interest in her magnum opus, Atlas Shrugged, published in 1957. The philosophical tale denounces altruism and applauds the actions of a fictional character, who steals from the poor to give to the rich.
The novel inspired none other than former federal reserve board chairman Alan Greenspan, who, during his tenure presided over an economic system that could not best be described as free-market capitalism, but socialism for the rich.
The so-called maestro was once marvelled for his achievements during the Great Moderation. But the aggregate numbers concealed a disturbing increase in income and wealth inequality that puts the United States on a par with developing economies such as the Ivory Coast and Jamaica.
Median household income stagnated during Greenspan’s tenure and fell well short of productivity. A sharp increase in consumer indebtedness ensued in order to maintain balance between supply and demand.
The surge in household debt in recent years has been well-documented, with the amount of outstanding debt increasing by more than 30 percentage points relative to GDP from 1997 to 2007, and by more than 40 percentage points relative to disposable income over the same period.
The increase in the debt burden was far more pronounced among the middle classes, who saw their debt-to-income ratio jump by almost 60 percentage points to 157 per cent between 2001 and 2007.
Meanwhile, debt-to-income ratios among the rich exhibited little change, as the wealthy captured an outsized share of income gains.
Staggering debt growth was accompanied by a precipitous decline in personal savings rates, which bottomed out at around 1 to 2 per cent from 2005 to 2007.
The combination unleashed a consumption boom that meant personal consumption expenditures increased from $7 trillion to $10 trillion from 2000 to 2007, capturing almost 80 per cent of real GDP growth during this period. All else being equal, if consumers had saved at the same rate as in 1980, they would have spent roughly $1 trillion less in 2007 alone.
Household balance sheets increasingly displayed unstable dynamics as income growth continuously fell short of interest rates, while households’ primary financial surplus dropped from almost 4 per cent in 1999 to below 1 per cent at the height of the housing boom.
Thus, America’s consumers became ever more dependent on asset bubbles to avoid a debt trap. The perilous state of household finances and subsequent retrenchment was an accident waiting to happen.
The middle-class debt binge is at an end, but current policies do little to address the inequalities that were a principal factor behind the Great Recession. Indeed, bank bailouts with public monies protect the wealthy and punish the middle class through higher taxes in the future.
Furthermore, quantitative easing may well have lifted stock prices, which benefits the wealthy. But it has also contributed to higher energy and food prices, as well as increasing mortgage rates, and thus placed further strain on stretched household incomes.
The economic recovery to date has not been conducive to income gains that might ease the middle-class plight. Indeed, the US labour market is almost seven million jobs shy of full employment and the number of jobs is unlikely to exceed its prerecession peak until the summer of 2014. The unemployment rate is unlikely to drop below 6 per cent until the winter of 2018.
The bleak state of the labour market is illustrated by the fact that the number of long-term unemployed continues to rise, while those out of work are more likely to leave the labour force than find a job.
The pressure on household income in the face of a soft labour market and limited access to credit has seen the government plug the gap and buoy personal consumption. Transfer payments, primarily unemployment benefits, account for more than 18 US cents in every dollar of personal income, a share that is almost 40 per cent higher than the long-term average that prevailed before the Great Recession.
Personal income excluding transfer payments is still more than 4 per cent below its prerecession peak and, in an unprecedented development, fell short of consumption through most of last year.
Wall Street economists are busy increasing their growth forecasts for the current year following Obama’s tax stimulus but – though economic momentum may remain favourable in the months ahead – the underlying picture remains extraordinarily fragile.
Analysis of the available data suggests that household consumption, which accounts for more than 70 per cent of GDP, is being kept afloat through transfer payments from the government.
However, without a vibrant labour market generating solid income gains, the economy will skate on thin ice.
charliefell.com
