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Joseph Stuber
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Joseph has been an analyst, investor, and student of economic theory; money and banking; and statistical methods for evaluating and implementing risk/reward trading algorithms since 1972. Joseph is also an occasional contributor to financial publications and his essays are frequently cited by... More
  • A Solution For Creating Stable Economic Growth And Why We Will Never Implement It - Part 1 Defining The Problem 1 comment
    Jan 22, 2014 4:58 AM

    We've experienced 18 recessions since the creation of the Federal Reserve in 1913. That works out to one recession every 5.5 years on average - hardly what one would call a stellar success in terms of managing the economy. The chart below is the Fed's version of the inflation adjusted Dow dating back to the period just prior to the creation of the current Federal Reserve central bank system.

    Perhaps most significant is the period of time we have spent in a secular bear market if one defines a secular bear market as the period of time spent after an all time high in real terms before a new all time high in real terms occurs. Using that definition we have spent considerably more time in secular bear market territory than we have in secular bull market territory. The periods reflected inside the red boxes are those sideways trends that constitute a secular bear market by the definition I am using.

    I don't want to start a debate on the definition of a secular bull/bear market here so would ask that readers understand that I recognize my definition is certainly not universally accepted. It does however, allow me to illustrate the point that in real terms the impact of inflation creates a situation where most of the time real gains are not being realized through stock ownership.

    That statement is certainly not intended to imply that stock ownership is ill advised and in fact stock ownership is one of the best ways to at least negate the impact of inflation on one's purchasing power and produce real gains over time as the inflation adjusted chart above reflects. One who bought the Dow in the early 80's at the inflation adjusted low of roughly 2000 would have been in pretty good shape even at the 2009 trough in inflation adjusted dollars. In fact one would have experienced a 4 fold increase in value expressed in real terms even after the market crash.

    That said, timing is of some significance here as one who had bought the bubble peak in 1929 would have waited around 30 years to register any real gains. The same situation applied to the early 60's peak. If one had bought that peak he would again waited almost 30 years to realize any real gains. In both instances a long term investment strategy where one is constantly making contributions over the course of the full cycle would lower the average cost of stocks and produce real gains on the aggregate holdings in a significantly shorter time frame than 30 years.

    Notwithstanding the fact that a long term strategy of investing in stocks would have produced significant real dollar gains over time the recessions become very problematic. Stocks are driven higher by increasing profits and that is a function of GDP growth in the aggregate and GDP growth is stalled out in a recession.

    It is generally agreed that roughly 70% of GDP is consumer driven and most of that consumption comes from the middle class. In a recession companies necessarily must cut costs and the biggest cost in most companies is labor. The conundrum is this - as unemployment climbs higher there are fewer dollars being spent and that exacerbates the problem of GDP growth. The result is a feedback loop with more and more consumers being laid off thus reducing GDP and necessitating even more lay offs.

    If government action isn't taken the situation would get progressively worse and at some point anarchy would ensue. The solution in part is to increase disposable income and there are a number of ways to accomplish that through policy. One of course is to reduce taxes leaving the consumer with more disposable income.

    Another solution is for government to do what companies won't do - pay consumers even though they are contributing nothing of value. Extended unemployment benefits, food stamps, Medicaid and cash welfare payments are examples of initiatives the government can embark on that will keep GDP positive even though unemployment levels are moving higher.

    Effectively implemented these programs can negate the impact of higher levels of unemployment - at least in the short term. That is exactly what occurred as a response to the Great Recession - the government stepped in to fill the void with massive levels of deficit spending.

    A look at a couple of charts shows that this is exactly what has occurred.

    The chart above shows that plunging GDP was turned around by a significant increase in government spending that was fully financed by the issuance of US Treasuries - in other words the government borrowed the money and spent it in order to prevent a further drop in GDP. The reaction to GDP was delayed but it did turn back higher and as the result of the governments fiscal policy action. Hard to criticize Congress for taking this step as the result absent the fiscal stimulus would have been that feedback loop that makes things get progressively worse as the consumer pool continues to shrink producing a devastating level of demand destruction that would most certainly end up in a prolonged depression.

    The chart above can be deceptive though in that the red line reflecting government debt growth appears to indicate that the government stopped spending after the initial surge in 2008. That is not the case at all - they merely slowed down the rate of growth in the US debt but each successive year since 2008 shows an increase over the prior year - just a smaller increase.

    A look at debt to GDP better reflects that dynamic:

    The chart above shows that government debt has been a major driver of GDP since the Great Recession as debt to GDP moved back to post WWII levels. Periods where government debt and deficit spending is a significant economic driver don't produce economic growth in real terms though. A look at the chart below identifies the two periods of real economic growth in the last 100 years. Both periods are identified by significant reductions in debt to GDP as the chart below illustrates.

    In all fairness to government fiscal policy one can't conclude from the above charts that the withdrawal of deficit financed fiscal stimulus produced real growth - to the contrary - it was real growth that allowed the withdrawal of fiscal stimulus in the first place.

    So back to the conundrum - we have for the most part throughout the last 100 years been dependent on fiscal stimulus to keep GDP in positive territory. The two periods that standout as exceptions are the post WWII period lasting roughly 15 years and the period from the mid 80's to the market peak just prior to the turn of the century - again roughly 15 years.

    The rest of the time has been identified by deficit spending that has driven debt levels higher. Therein lies the conundrum in that higher debt levels imply higher levels of taxation in order to service the debt and the larger the tax bite the less disposable income which works to dampen GDP growth. That means that over time the levels of deficit spending need to increase by a magnitude sufficient to offset the increase in tax receipts and then a little more to produce GDP growth.

    What we see today is that the increase in the level of deficit financing needed to maintain GDP in positive territory has taken on a parabolic look. But for the first time in 100 years the fiscal stimulus is not really working. One can look at the unemployment rate and assume that is not true - in other words unemployment levels are coming down meaning more and more are moving into the consumer pool and that will drive demand. That is after all what has happened in times past. Fiscal stimulus has provided the needed jump start to push unemployment levels down and the offshoot - higher numbers of employed and higher GDP.

    It just hasn't happened this time around though. A close look at the debt to GDP chart above since the end of the recession shows a parabolic almost vertical shot higher on debt to GDP while the total numbers of people employed is hovering at about the same level it was pre-recession. That is a lot of stimulus and for very little in real gain. The blue line in the chart below shows the actual numbers of those employed. The red line is the total population showing that even though we are growing the population at a relatively steady pace and a pace that is no different today than pre-recession we are flat lining on jobs.

    Look at this chart - the official unemployment rate - if you want to feel good about the prospects for growth going forward. Looking at the chart below one would think we were doing great things as the unemployment rate has fallen sharply since the end of the recession.

    Look at this next chart if you want to know what's really going on. The only reason the unemployment rate chart looks good is because this one looks so bad. The Labor Force Participation Rate has fallen to a 35 year low.

    The truth is we are in real trouble and brings me back to the conundrum. We are keeping GDP in positive territory because we are doing what we've always done in times of trouble - borrow and spend. The problem this time around is that it is taking a lot more to just maintain the status quo and at some point very soon the law of diminishing returns must kick in.

    How long can we stay on this path? A point I tried to make in a previous article and will make again is that the burden of the increasing debt falls squarely on those remaining in the work force - a rapidly shrinking work force.

    A look at the chart below is telling. In 2008 personal tax receipts were roughly $1.18 trillion. Today personal tax receipts are just a little less than the 2008 level but the debt since the recession is just short of double what it was in 2008.

    The chart below shows tax receipts - both personal and corporate. Lest anyone get the idea that corporations bear a significant portion of the tax burden in the US the chart below will clear that misunderstanding up quickly.

    And here is the debt level the tax payer is ultimately responsible for and even though the tax payer has been given an extension on payment of the obligation - out of necessity - it will ultimately have to be dealt with.

    The fact is personal tax receipts are essentially the same today as they were pre-recession but the money borrowed on behalf of the tax payer has almost doubled. That is just not a business model that works. And it all boils down to this - a debt driven economy based on ever increasing government debt levels will eventually blow up.

    The truth is we are much closer to that blow up point than most are willing to acknowledge. The reason I know that is the magnitude of the deficit spending and what we are getting for it in return. And we aren't getting much if one looks at the data objectively. We have no historical perspective for what we've seen post recession.

    Some will argue that the debt to GDP levels post WWII were as high as we are today and I would agree with that. However, after the war the debt to GDP ratio began a rapid descent. That ratio fell by roughly 65% in the 15 years following the end of WWII. If we were to repeat that today we would need to expand GDP to roughly $45 trillion without any increase in government debt. The only way that will happen is for nominal GDP to spike higher based on a massive expansion in M2 that produces the most severe inflationary environment the nation has ever known - a move that would literally destroy the US dollar and life as we know it.

    A capitalist with a populist perspective

    In a recent article entitled Why We Are Not OK And Not On A Sustainable Trajectory I made the following comment that sets the stage for the balance of this discussion:

    The truth is we are in a "beggar thy neighbor" market dynamic today but it is not so much a matter of one sovereign country gaining at the expense of another. It is more a matter of big banks and big corporations - with no sovereign allegiance at all - gaining at the expense of the masses in all sovereigns.

    Lest one question that a look at the chart below should remove any doubt. The chart is after tax corporate profits as a percent of GDP.

    Corporate profits as a percent of GDP did take a hit after the stock market bubble burst in the late 90's but it wasn't long before those profits as a percent of GDP put in a new all time high. Then we had the second crash and profits once again fell sharply before being reinflated again to new all time highs.

    Here's another look at corporate profits - this time before tax - compared to Proprietors Income - a proxy for small business. The chart is courtesy of Ed Dolan and the full article is found here:

    Now to the banks or should I say the big banks. The following chart is of the total asset base of all commercial banks.

    It was in fact the big banks reckless behavior that produced the Great Recession in the first place but as the chart above shows the big banks have just gotten bigger. In fact what disturbs me the most is the parabolic spike in bank assets during the recession. A look at the chart above suggests that the big banks actually benefited by the recession and indeed they did. It is the way the system is set up and the focus of Part II of this two part series.

    For now though let me sum it up this way. I am a fervent believer in capitalism but also recognize that for capitalism to work it must work for all of us. Wealth begets more wealth and taken to it's extreme it will eventually collapse upon itself.

    When a disproportionate share of the wealth is concentrated in the hands of a few to the detriment of the many the many are prone to revolt and that must be the real fear of those at the top of the rung. More importantly though is the fact that the middle class is the driver of the economy including corporate profits and a systematic process of destroying the middle class almost presents itself in a way that seems to suggest the big companies, the big banks and the political class have an almost masochistic death wish mindset.

    And unfortunately we are moving at a very rapid rate toward the destruction of the middle class and it is the middle class that is the foundation of a well oiled capitalistic machine. Today we see a major consolidation of wealth in the hands of a few. The numbers of banks in the United States has fallen from 14,427 in 1985 to 6,012 in 2012 per the FDIC.

    More importantly - the big banks just keep getting bigger. Here's how Pat Garofolo explained it in an article he wrote about a year ago:

    As the nation slowly ground its way out of the Great Recession, the biggest banks in the country (whose malfeasance played a large role in creating the downturn) grew even larger. According to data from the Dallas Federal Reserve, the largest 0.2 percent of all banks now control nearly 70 percent of all banking assets:

    As of third quarter 2012, there were approximately 5,600 commercial banking organizations in the U.S. The bulk of these-roughly 5,500-were community banks with assets of less than $10 billion. These community-focused organizations accounted for 98.6 percent of all banks but only 12 percent of total industry assets. Another group numbering nearly 70 banking organizations-with assets of between $10 billion and $250 billion-accounted for 1.2 percent of banks, while controlling 19 percent of industry assets. The remaining group, the megabanks-with assets of between $250 billion and $2.3 trillion-was made up of a mere 12 institutions. These dozen behemoths accounted for roughly 0.2 percent of all banks, but they held 69 percent of industry assets.

    On the corporate front I am puzzled at the comments I hear about the little Ma and Pa proprietors being crushed. Is there really any Ma and Pa operations in existence today? A few I guess but how long do they last? I don't have data on this but my guess is that most Ma and Pa operations are started by people who have the naive assumption that they will capture a part of the American dream by starting a little shop somewhere and building it up over time.

    What are the chances of that occurring though? You just can't compete today against the big guys. I always try out the little Ma and Pa restaurants when they first open up and invariably find that many of them are far superior in quality than the international chains but a persistent theme in most of these cases is that they go out of business at that point where they've lost all their seed capital.

    The same applies to hardware stores, clothing stores, niche supermarkets and other small operations - they just can't compete with the big corporations. And the big corporations are international in scope with no sovereign allegiance. McDonald's is just as content selling a hamburger to the Japanese as they are to those in the US. The same applies to Apple or IBM or Caterpillar - well you get the point.

    In an article by Sarah Anderson and John Cavanagh entitled Top 200: The Rise of Corporate Global Power the authors make the following points:

    • Of the 100 largest economies in the world, 51 are corporations; only 49 are countries (based on a comparison of corporate sales and country GDPs).
    • The Top 200 corporations' combined sales are bigger than the combined economies of all countries minus the biggest 10.
    • While the sales of the Top 200 are the equivalent of 27.5 percent of world economic activity, they employ only 0.78 percent of the world's workforce.
    • A full 5 percent of the Top 200s' combined workforce is employed by Wal-Mart, a company notorious for union-busting and widespread use of part-time workers to avoid paying benefits. The discount retail giant is the top private employer in the world, with 1,140,000 workers, more than twice as many as No. 2, DaimlerChrysler, which employs 466,938.

    I am all for capitalism but recognize the importance of the consumer in that paradigm. What we've seen going on for decades now is a slow but focused process that has relegated the working class to the back of the bus. And it can't end well.

    We have a political class that struggles between giving us what we want to retain votes and giving those who are working against us what they want to enrich themselves. Some of you may be familiar with this quote. You will find it in the book of Matthew:

    No one can serve two masters, for either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve God and money.

    Regardless of your beliefs the words tend to ring true. I would like to suggest that our political class has chosen to serve the money by succumbing to the lobbyists of the big corporations and at the expense of their constituents.

    One area in particular where our political class has caved in to the will of the big corporations is in the area of antitrust laws. The consensus view today as it relates to anti-trust actions is that the primary focus must be on the consumer and that means this - does the price the consumer pays to those who effectively hold semi-monopolies benefit or hurt the consumer?

    The answer in most cases is that it helps the consumer. Wal Mart is a great example. So is Home Depot or McDonald's. The list is long of companies that crush competition by selling goods at very low prices and that is what has allowed them to thrive. But the efficiencies of scale that help the consumer in one respect tend to hurt them in another and perhaps more important respect. Wal Mart for example offers the consumer very low prices but they do so by maintaining a very low labor cost.

    Interpretation of The Sherman Antitrust Act is one of many major shifts in policy that has allowed the systematic transfer of power into the hands of a few. Judge Robert Bork's book - The Antitrust Paradox - formed the views of the courts since the early 80's and has played an instrumental role in allowing this massive consolidation of power. Here is how Wikipedia explains the consensus view:

    Bork argued that the original intent of antitrust laws as well as economic efficiency make consumer welfare and the protection of competition, rather than competitors, the only goals of antitrust law.[3] Thus, while it was appropriate to prohibit cartels that fix prices and divide markets and mergers that create monopolies, practices that are allegedly exclusionary, such as vertical agreements and price discrimination, did not harm consumers and so should not be prohibited. The paradox of antitrust enforcement was that legal intervention artificially raised prices by protecting inefficient competitors from competition.

    The book was cited by over a hundred courts.[1] From 1977 to 2007, the Supreme Court of the United States repeatedly adopted views stated in The Antitrust Paradox in such cases as Continental Television v. GTE Sylvania, 433 U.S. 36 (1977), Broadcast Music Inc. v. Columbia Broadcasting System, Inc., NCAA v. Board of Regents of Univ. of Oklahoma, Spectrum Sports, Inc. v. McQuillan, State Oil Co. v. Khan, Verizon v. Trinko, and Leegin Creative Leather Products, Inc. v. PSKS, Inc., legalizing many practices previously prohibited.

    The Antitrust Paradox has shaped antitrust law in several ways, prominently by focusing the discipline on efficiency and articulating its goal as "consumer welfare." Many lawyers and economists, however, have pointed out that Bork was wrong in his analysis of the legislative intent of the Sherman Act and have criticized him for incorrect economic assumptions and analytical errors. One of the key criticism focuses on Bork's use of the term "consumer welfare," which became the stated goal of American antitrust law.

    For what it's worth I am not against Wal Mart or McDonald's or Home Depot or any of the big international corporations who have managed to exploit their advantage for profit. That is what capitalism is all about and were I in a position to establish policy at any of these companies I too would argue that the companies are doing a fantastic job of delivering goods at very low prices and that helps consumers.

    However, if I were a legislator I would see my role as balancing the issue between helping the consumer on the one hand and hurting a significant portion of that consumer base on the other hand with poverty level wage structures. There is a very pragmatic argument to be made for why protecting and improving the financial condition of the middle class is beneficial to even the large corporations. As the methodical process of demand destruction continues those international corporations will suffer along with the rest of us.

    And in the sense of fairness as it relates to the obligations that big corporations have to society one must conclude that they are where they are today because of the middle class and because of the political class who has facilitated their rise. And are they bearing a proportionate part of the burden? Well a look at corporate tax contributions in the chart above attests that they clearly are not doing so.

    The second part of this two part series has to do with one issue - restoring a balance of power to the middle class. The ideas I will present will be perceived by some as radical. In fact I find them very radical myself and will readily admit that I have been very slow in coming to these conclusions - especially the one that relates to our system of fractional reserve banking.

    The truth of the matter is this - we are so heavily burdened with debt today that we simply can't overcome it by growing the economy. The magnitude of unfunded liabilities is so extreme and the demographic structure that these unfunded liabilities are dependent on are so out of kilter that there is no way we can continue to kick the can without dire consequences. The situation calls for radical change and that is what I would like to see happen. Will anybody listen? Probably not - at least not until all other measures have proven futile.

    This problem is not unique to the United States though. It is global in scope but with that caveat properly explained I would still suggest that the following comment from Winston Churchill states the course we will follow:

    You can always count on Americans to do the right thing - after they've tried everything else.

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  • John Wilson
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    I missed the publication notice of these two blogs. I see they are long. I will take the time to read them this end of week and weekend. I am just taking a first look right now.


    I agree that SA readers miss instablogs a lot. Short attention spans I guess.
    30 Jan 2014, 08:08 AM Reply Like
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