Post-Labor Day Investment Thoughts: Financial Advisors' Daily Digest

by: SA For FAs
Summary

A Nobel Prize-winning economist looks at income inequality, and your correspondent adds his thoughts.

Martin Lowy and BeattlesRockerTom analyze the causes of America’s changing economics.

Jeff Miller’s “Weighing the Week” questions the evidence for an imminent market collapse.

Growing up during the Cold War, I shared the common understanding of the difference between the two opposing sides. The contest between the U.S. and the Soviet Union was not just a geopolitical one, but an ideological one between liberty and equality, along with a big asterisk. The asterisk was the understanding that America, besides being a beacon of liberty, also enshrined equality before the law and equality of opportunity. Citizens of the Soviet Union and Eastern Bloc nations “enjoyed” some sort of theoretical equality, but everyone knew that it was not unlike the system under the stars, in which the Soviet aristocracy had their dachas on the Black Sea, while the proletariat lived like serfs, albeit with even less freedom.

I still hold this basic view – my college years did not shake them (though I was surprised at how revisionist my fellow students could be). But the question arises today as a result of increasing anxieties about growing inequality in the U.S. A regular reader and commenter in this forum alerted me to this discussion of rising inequality in the U.S. by Nobel Prize-winning economist Peter Diamond. While I generally eschew this sort of topic, I figure it’s suitable for the day after Labor Day and for readers who stick with this, I promise one related investing insight at the end.

Below I excerpt a few of Diamond’s basic observations:

the relative size of the middle income group has been shrinking.”

“We've seen significant sustained rises in income inequality”

“we have a long-run problem in the United States of people with low education having very stagnant earnings on average.”

I think the above findings are widely agreed upon today as matters of fact. They are indeed problematic. A more controversial assertion, one about which Diamond is admirably cautious, is that “the growth of financial services has come with huge amounts of income for people in those professions and there is a huge attraction of people to those occupations.” The question he poses is whether the increased “financial engineering” we’re seeing in the economy is merely improving efficiency, and thus people engaged in it deserve their huge incomes, or whether there’s a sort of manipulation taking place, as he puts it:

If, on the other hand, what is going on is a radical change in the risk allocation associated with more gambling, to put a blunt word on it, with more trade based on differences in subjective probabilities, more focus on getting out products that people don't understand, then that is a quite different story…If that is right, and I have not seen anything succeeding in fully sorting this out, then we'll have policy implications.”

I actually didn’t understand some of the above paragraphs, but if a Nobel Prize-winning economist hasn’t yet sorted out what is increased efficiency and what is reckless gambling, then I won’t try to either. Instead, I’ll offer a few of my own thoughts, along with that promised investing implication.

It is difficult, to say the least, to counter the causes of growing inequality. Globalization and technological change spread many benefits at the same time that they make it harder for the middle class to keep up financially. And besides, who is the President of Globalization to whom we could appeal for middle-class-friendly changes? Diamond cites the decline of trade unions as a factor in the plight of workers, but I’m not convinced that is a bad thing. Stronger unions as existed in other countries became dictatorships unto themselves, wielding enough power to bring national economies to their knees. And where they have gained strength in the U.S. – basically in government, ironically – they have been strong contributors to fiscal imbalances and pension crises.

Diamond discusses potential policy responses, some of them conventional like a reinvigorated estate tax, and some less conventional like a universal grant to those turning 21 to help them launch their careers (indeed, the estate tax is what would fund this grant, in his telling). I don’t think these ideas can be lightly dismissed. Many people will surely regard these or other ideas as social engineering. My own view is that the more “financial engineering” we have now, the more “social engineering” we’ll end up with later. As I’m skeptical of government’s knowledge and competence in instituting large-scale corrective programs, I favor programs that empower individuals. For example, if every American were given vouchers to choose whatever educational or vocational program that might further them along educationally and professionally, that I think would have more favorable outcomes than the current system in which federal student loans fatten the coffers of a dysfunctional system of higher education.

But renewing people’s capacity to improve their income through education is only part of the equation. Here’s that investing implication. From what I have seen, the equality gap is less a function of declining labor income than a consequence of a disparity in capital. So my key takeaway for investors – fully aware that it could actually exacerbate the problem if heeded only by those currently investing – is that the surest path toward wealth is by owning assets such as stocks and real estate. Of course, it takes making a living to fund those investments. One way or another, we will need to somehow press a re-set button on America’s socioeconomic crisis.

Labor Day is not meant to be about barbecues. America was the moral champion in its battle with the Soviet Union because its system of government allowed for people’s independence and dignity. In the Soviet Union, people worked for the state and suffered privation. In contrast, in the U.S., people could work hard and enjoy the fruit of their labor. That’s still the case, but we need to shore up the American worker’s financial position through education, work and ownership.

We welcome your thoughts in our comments section, as always. For now, here are other financial advisor-related links: