- Artificial intelligence and robotics are the root of our economic problems.
- We've already tested the plan, and it does work.
- Our biggest problem is educating policy makers and the public on how our economic system really works if we are going to overcome the dogmatically entrenched resistance to fully implementing the plan.
Many will disagree with my thesis in this essay, but one thing almost all of us can agree on is that this presidential race is easily the most entertaining one we've ever witnessed. The fact that Donald Trump and Bernie Sanders are being taken seriously sends a loud warning to the political class that we have problems, and that they aren't being resolved.
Many of us think anything other than the status quo would be an improvement, and only Sanders and Trump are really offering a hope for that new paradigm. Trumps solution - take an isolationist stance. Sanders solution - take Keynesian economics to a new level.
My own view - Sanders is the only one who is offering solutions that can actually work. That said, I am not sure he fully grasps the real nature of the problem. After all, Sanders, if nothing else, has been consistent in his populist views for over 30 years, and the problems we face today are dramatically different than the problems we faced in the 1980's. In the most recent debate Sanders sounded like he thought all would be well if we could just get rid of the shale industry, Wall Street, the Fed, and the Koch brothers. If that is what he really thinks he is clearly wrong. That said, he still may hold the key to reviving economic growth even though he is wrong on his base assumptions.
Many economists and analysts see the mountains of debt that have been amassed over the last several decades, and in particular, since the end of the Great Recession, as the root of our problems. That is not the problem although it is easy enough to see why so many think so. The truth is we necessarily must expand money supply to accommodate growing populations, and to embrace new technologies. And, under the fractional reserve system, the only way we can expand money supply is to borrow it into existence. Therefore, without the massive levels of debt that we've created over the years, both public and private sector debt, we would be in a much worse situation today than we presently are, and make no mistake, we are in a very bad way right now.
The root problem is simple - we just don't need as many people as we once did to produce the goods and services that we are capable of consuming. And, with automation replacing millions of jobs we end up with the unfortunate consequence of a consumer class that is simply unable to drive economic growth. The fact is simple, we have a labor glut of significant proportion, and that makes it possible for corporations to exploit that oversupply. But, unfortunately, part time workers, and low paid workers simply can't drive GDP growth.
Our short term response to this condition has been massive levels of deficit financed fiscal stimulus. That is a subject that is only discussed in passing in this age of central bank financial engineering with the constant emphasis being on the Fed, and the Fed's policies, rather than Congress and fiscal policies. But, the truth is central banks ran out of tools to effect economic growth when they moved short term rates to zero. Since 2008 the Fed has done almost nothing to stimulate economic growth (they have supported risk asset appreciation though) other than to support the massive levels of fiscal stimulus that government has injected into the economy. We can see that in the chart below. Household debt has stopped increasing. And, the reason is simple - to support household debt we need wage growth, or in the alternative, we need to see lower interest rates that reduce the cost of carrying debt. Wage growth peaked some time back, and when the Fed went to ZIRP that economic driver ended as well leaving government with the only response possible under our current paradigm, borrow and spend for us.
Was government's response irresponsible? Absolutely not, and in fact, it was the only response available to keep us out of depression. And, it wasn't as problematic as so many pundits want to claim. To illustrate the point, the chart below plots the increase in Public Debt as a percent of GDP alongside the interest cost on that debt as a percent of GDP. What we see is that our Debt to GDP ratio is as high as we've seen in the last 40 years, but our carry cost on that debt as a percent of GDP is the lowest we've seen in the last 40 years:
There are a lot of troublesome metrics we can look at that suggest we have serious problems ahead, but it is hard to say that the explosion in federal debt is really that big a problem when you also consider that the Fed has reduced the carry cost as a percent of GDP by more than 50% from the 1990 high. Additionally, the Fed paid $98.7 billion to the US Treasury in 2015 based on interest payments the Fed received on government debt holdings. That represented 2.7% of the 2015 Federal Budget.
Conclusion - debt is simply not our problem, and in fact, it can be argued that we need more of it, not less, as the only way we drive economic growth is to spend money. The more we have of it in the right place the higher the growth rate. But, and this is a big one, economic growth can no longer be dependent on the working class - at least not in the traditional sense that they will earn high wages which they will spend to buy goods and services.
Defining the new paradigm
We can start by stipulating a fact that we all can agree on - our present policy moves, both fiscal and monetary, haven't worked to restore economic growth to the levels we had hoped for. I am reminded of a comment Albert Einstein made that seems apropos here:
"If you can't explain it simply, you don't understand it well enough."
Well, the simplest way I can think of to explain our current problem is that economic growth is dependent on a feedback loop:
Feedback occurs when outputs of a system are routed back as inputs as part of a chain of cause-and-effect that forms a circuit or loop. The system can then be said to feed back into itself.
Capitalists are dependent on those people, who in the aggregate, work for them. Companies pay workers who in turn spend the money they receive to buy the goods and services the companies produce. In a growing economy the money companies receive increases over time, and companies spend an increasing amount of money on capex, inventory, and wages. Where the positive loop breaks down is when a labor glut allows companies to exploit the working class in order to generate profits. In the short term this can be a positive for corporate earnings. But, the longer term negative consequence of stagnant wages and high levels of unemployment resulting from a labor glut is that the companies who are cutting costs by reducing labor compensation are negatively impacting the feedback loop.
If we focus strictly on the headline unemployment numbers we can draw the conclusion that we don't have a labor glut:
However, the headline unemployment number doesn't tell the full story. Governments - being what they are - are inclined to manipulate numbers in ways that make data metrics look better than they really are, and that is certainly the case with the headline unemployment number. The real truth is better reflected in what I call the governments propaganda variable - the labor force participation rate. Most of us already understand how headline unemployment rates have been manipulated, but for those who don't, the chart below depicts the labor participation rate alongside the employment/population ratio - two different metrics that depict the same structural problem:
Another metric we can look at that confirms the existence of a structural problem resulting from automation is income:
Clearly the two metrics above inform us, and the take away is that something has changed. And, more importantly, traditional approaches in fiscal and monetary policy haven't been as effective in alleviating the problems as they have in the past. Pew Research addressed the subject here in a piece entitled AI, Robotics, and the Future of Jobs. Their findings are summarized as follows:
Some 1,896 experts responded to the following question:
The economic impact of robotic advances and AI-Self-driving cars, intelligent digital agents that can act for you, and robots are advancing rapidly. Will networked, automated, artificial intelligence (NYSE:AI) applications and robotic devices have displaced more jobs than they have created by 2025?
Half of these experts (48%) envision a future in which robots and digital agents have displaced significant numbers of both blue- and white-collar workers-with many expressing concern that this will lead to vast increases in income inequality, masses of people who are effectively unemployable, and breakdowns in the social order.
The other half of the experts who responded to this survey (52%) expect that technology will not displace more jobs than it creates by 2025. To be sure, this group anticipates that many jobs currently performed by humans will be substantially taken over by robots or digital agents by 2025. But they have faith that human ingenuity will create new jobs, industries, and ways to make a living, just as it has been doing since the dawn of the Industrial Revolution.
My own view is that the second group, those that assume we will deal with the problem, are typical of those who refuse to admit the real problems we face today in the first place. Among those in denial, at least publicly, are the Fed's own members who continue to deny the fact that our problems with stagnant growth, are in fact, structural. You can deny a truth, but that doesn't mean that which you deny to be true is, nonetheless, true. This quote from one of the group of naysayer's that contend automation will have a devastating impact on the economies of the future seem more apropos than those who insist on viewing all things through rose colored glasses:
Jerry Michalski, founder of REX, the Relationship Economy eXpedition, sees the logic of the slow and unrelenting movement in the direction of more automation: Automation is Voldemort: the terrifying force nobody is willing to name. Oh sure, we talk about it now and then, but usually in passing. We hardly dwell on the fact that someone trying to pick a career path that is not likely to be automated will have a very hard time making that choice. X-ray technician? Outsourced already, and automation in progress. The race between automation and human work is won by automation, and as long as we need fiat currency to pay the rent/mortgage, humans will fall out of the system in droves as this shift takes place…The safe zones are services that require local human effort (gardening, painting, babysitting), distant human effort (editing, coaching, coordinating), and high-level thinking/relationship building. Everything else falls in the target-rich environment of automation."
The most difficult part of assimilating AI and robotics into our society is to make people understand that the new technologies do make our lives better, but they also have a massively huge, long term negative impact on our economic system - at least as that system is currently constructed. And, we just don't like change, nor will we readily accept a new thing that flies in the face of our old system of beliefs.
We are about to make a huge leap here, and it will fly in the face of everything we've been taught. It is time to take Keynesianism to new extremes. And, it is really the only viable approach we have to keeping the economic feedback loop alive. Some, of late, have admitted that the only real solution to our problem is "helicopter money". I agree.
So, how exactly would that work? Well, my own view is that our Internal Revenue Service, the Federal Reserve, and the US Treasury should work in concert by employing a very simple system of income redistribution that moves money that is currently being hoarded, in a manner of speaking, by those who have high net worth's and high incomes to those on the opposite end of the spectrum.
This money hoarding I speak of was explained by Keynes as a liquidity trap. People just quit spending, instead hoarding cash. The result - a major contraction in the money velocity rate. This liquidity trap I am speaking of is not the same thing Keynes spoke of though. Rather, it is a function of moving newly created money out of the real economy system, and into the risk asset system. As long as newly created money is left in the real economy system it will be spent for goods and services, and in so doing, drive economic growth higher. A symptom of the liquidity trap I speak of is that money velocity has fallen dramatically even as deficit financed government stimulus has driven money supply higher.
In an essay I wrote in July of 2015 -Why Organic GDP Growth and Inflation Elude Us - The X Factor - I used the following graphic to illustrate the liquidity trap I am referring to here:
The graphic above shows that money flows from buyers of goods and services to sellers of good and services. Sellers of goods and services use a portion of that cash to pay wages, taxes, and to replenish inventories pushing it back the other way. And that money is then spent once again thus repeating the process.
But a portion of the money that flows from buyers of goods and services to sellers of goods and services is captured as profits, or paid out to high income earners employed by the company. That cash is effectively excess cash that the company doesn't need to spend to conduct their business operations, and in the case of high income earners, to maintain their lifestyle. That money then moves out of the Real Economy System and into the Risk Asset System.
The metric that best confirms the liquidity trap condition referenced above is money velocity. The chart below of M2 money stock velocity is particular disturbing, and in fact, suggests a very serious condition in terms of the breakdown in the feedback loop that we depend on to drive economic growth. In simple terms, we are creating enough money, but more and more of that money is flowing in one direction - to companies and high income earners. It is not being sent back into the real economy by companies who then spend it to buy inventories needed in a growing economy, or to expand plant and equipment, also something we would expect in a growing economy.
In an attempt to keep it simple, as Einstein suggests we will do if we understand the matter, consider this very basic equation:
Gross Domestic Product (NYSEMKT:GDP) = Money Supply (M2) x Money Velocity (M2V).
GDP is the metric we use to measure economic growth, and GDP is fully dependent on the supply of money in our economy, and the velocity of that money, or in simple terms, the number of times a single dollar turns over in a given year.
The chart below adds M2 money stock to the chart of M2V. It shows that we have increased money supply dramatically since M2V peaked in 1997, by a factor of more than 3 times in fact. Keep in mind that the only way we can increase M2 is to increase debt, either through private sector borrowing, or through government borrowing. And, the lending must be done through a private sector bank, a bank that operates in the traditional fractional reserve bank system, not a loan that is made through a shadow bank.
One can state that the problem is money velocity when looking at these two metrics, and to a degree that is true. However, that is simply not the root problem. M2V is declining for one reason only, the economy is not growing, and therefore a large portion of the money that moves into the coffers of companies is not spent back into the economy meaning the feedback loop we depend on is being compromised. And the reason the economy is not growing is simple enough - we have a labor glut meaning M2V is a symptom of the root problem, not the problem itself.
In 2012 I wrote an essay entitled High Unemployment - The New Economic Paradigm. In that essay fellow Seeking Alpha contributor Lawrence Kramer made the following comment. His comment was so far to the left that I wrestled mightily - forcing myself to be objective, and allowing my objectivity to overcome my decade's old dogmatically entrenched beliefs on how things should work. Certainly the idea of government welfare for all was diametrically opposed to those things I had been taught, and more importantly, had come to believe in with an evangelical fervor. Yet, wasn't I the one who broached the subject in the first place with my essay. Here is what he had to say:
We need to recognize the special way in which BHO's "you didn't build that" claim holds true. Not as a denigration of entrepreneurship - it was never meant as such, and, more important, its truth lies elsewhere - but as a statement of NATIONAL achievement. We have built a synergistic legal, social, and economic system that enables our entrepreneurs to produce untold quantities of stuff, now with very little input from the rest of us. But the rest of us still "contribute" to the system by participating in it as non-rebelling, law-abiding citizens, by not asserting our "Second Amendment rights" to kill The Man. We don't perhaps deserve a medal for our self-control, but it must be acknowledged as a political reality. America is the land of opportunity BECAUSE of things the capitalists did not build. If you're born on third base, you can take credit for stealing home, but not for hitting a triple.
In a post-labor world, it's not at all clear that monetization is unsustainable. All money is debt, yet no one complains that commerce itself is "unsustainable," even though the debt outstanding in 2012 is considerably greater than that outstanding in 1789. Why is that not "unsustainable"? Monetization by the Fed is no different, in this particular regard, from fractional reserve banking. Bankers create money out of thin air because there is value for it to buy. There is no reason that the government could not do likewise. Yes, it is possible to print TOO much money, and we need a governmental technology for preventing that. The semi-independent central bank is the current iteration, and it may continue to be such so long as currency stability remains in its mandate. The unemployment part of the mandate probably has to go, though.
That was 4 years ago, and today I am more certain than ever that Mr. Kramer was right. My objectivity won out over my dogmatic belief in the old system. The evidence is simply too overwhelming to conclude otherwise. We can no longer depend on a wage earner driven economy. But, can we REALLY move even further in the direction of a national welfare state?
Of course we can. In fact, we've already implemented a good portion of the model for doing so with the massive fiscal stimulus we've engaged in since the end of the Great Recession coupled with the Fed's QE policy. Did that plan work? Damned right it did, and that too is a blasphemous statement to make in the world I grew up in. In fact, I have been as vocal as most on pointing out the flaws in both fiscal and monetary policy since the Great Recession. But, I have also held on to my objectivity in the sense that I have pointed out time and again that the alternative to these policies would have been a lengthy depression. I have used this chart on a number of occasions to make that point:
We keep on asking the question - is fiscal and monetary policy working? And, based on most of the metrics we look at, in particular, from an historical perspective, we keep on coming up with the same answer - NO. Really? The chart above suggests otherwise. Granted, GDP growth has slowed dramatically, but it has remained modestly positive. Without massive levels of government spending that would not be the case as the chart above shows. In fact, we would have been in depression since the turn of the century, and it would have been much worse than the chart suggests.
When any government body pays wages, or buys goods and services, it impacts society as a whole in a positive way. If the US government buys a fleet of automobiles it helps those who earn a wage building automobiles, and that helps all of us as that wage earner might spend his wages on something we make. When a government employee buys a computer, a house, a car that helps all of us.
Are those who support less government really cognizant of the consequence of less government? Again, I am speaking blasphemy here I suppose, but objectively speaking, are we better off when government inspectors make sure the planes we fly in are safe, the buildings we work in are safe, the cars we drive are safe, the medicines we ingest are safe, and the food we eat is safe? How about our military, or our police and fire departments? Would we rather these services be provided by private companies with a profit motive? The inconvenient truth for those who abhor government is this - as bad as it often appears, we are much better off with the services government provides than we would be if those services were privatized. Plus, we get the added benefit of all that money being spent to prop up the economy, e.g., the policeman, the soldier, or the fireman who receives a check from the government and spends that check with private sector companies to buy goods and services.
Just to put the matter in perspective, we can look at these two pie charts:
Looking at the federal spending chart, one can see that almost ½ of government spending is mandatory payments to social security and healthcare. When you add defense spending into the mix you end up with 65% of total spending. Throw in "other mandatory" and "net interest" and that leaves only "non-defense discretionary" as a possible area we could reduce.
On the income side, 80% of government receipts come from payroll and income taxes. As a practical matter, few of us would support the idea of cutting any of these expenses, but we would - to some degree - justifiably protest the idea of raising taxes to cover the deficit. Furthermore, most of the checks the government writes are a good thing in that the money they distribute into the economy is spent to buy goods and services thereby keeping us in positive territory on GDP growth as the chart above indicates.
But, back to the point - is it possible to sustain a system of "government welfare" that we will need to support GDP growth through the process of continually incurring annual deficits? The answer is yes, and to some degree we have demonstrated that since the end of the Great Recession.
In fact, it can be argued that despite what some say is a policy of unsustainable deficit spending, US Treasuries remain the safe haven investment as indicated by the high demand for these instruments. Consider that Japan has been engaged in deficit financed fiscal stimulus and QE a lot longer than any other developed economy, and yet their bonds are not falling in value. To the contrary, they remain a safe haven play even at negative yields:
And, this is in spite of a debt to GDP ratio that is dramatically higher than the US. Critics of course will be quick to point out that the high levels of fiscal stimulus and QE have not worked as Japan's economic growth, is at best, flat lining - i.e., they are constantly moving in and out of recession. That is true, but it is also true that had Japan not engaged in these extraordinary measures their economic growth would have certainly been even worse so is it reasonable to say that these policies have not worked if the goal is to keep Japan above the zero line on GDP growth? Perhaps not.
The point is this - Japan has proven, to an extent, that deficit financed fiscal stimulus doesn't automatically mean that a government's debt loses value, particularly when the government's central bank offers whatever support is needed through QE. To the contrary, as noted above, investors have driven the price of the 10 year to the level where those who buy the bonds actually lose money carrying it to maturity.
The truth is really quite simple - we could theoretically eliminate all taxes without reducing government expenditures. There is nothing that I know of that precludes the US government from issuing $3.5 trillion a year in new issue debt instruments other than the approval of Congress. And, there is nothing stopping the Fed from buying 100% of that new issue, if necessary, and in so doing, reduce the carry cost on this new debt issue to zero (i.e., not a consequence to taxpayers even if we didn't eliminate taxes).
Keep in mind, the only thing that really matters here is the cost of carrying the debt, not the debt itself. Certainly those who don't understand the matter seem bent on stressing the point that we can't continue to expand our federal debt levels indefinitely, but that seems pretty well refuted by the fact that we have been expanding our federal debt for over 200 years.
For those in the fiscal conservative camp that advocate for a balanced budget, or even a reduction in total debt, keep in mind you are advocating for a contraction in the supply of money. And, by extension, if you reduce the supply of money, you are necessarily, by definition, shrinking GDP (GDP = M2 x M2V). Not a good plan.
There are 3 problems with a plan that increases government welfare through deficit spending:
- Getting everyone to buy-in.
- Figuring out a way to drop the newly created "helicopter money".
- Making sure the feedback loop works to avoid increasing the wealth and income disparity.
Number 1 will come - to some degree - out of sheer necessity at some point, and in fact, it already has become an integral part of our societal construct whether we like it or not. We are clearly a hybrid economy where those who can make it in the private sector do so, and those who can't receive a variety of government subsidies.
One solution for distributing the "helicopter money" is through the implementation of a more exaggerated progressive tax rate structure. I spent a good deal of time working on just such a structure and came up with the following as a possibility. The tan line on the chart shows the effective tax rate in the aggregate at each of the selected income level caps. The blue line shows the proposed rate changes. Where the blue line is below the zero line on the chart it indicates a negative effective tax rate. Our current tax code provides for a negative tax in the form of the earned income tax credit. None other than Warren Buffet has advocated for an increase in the use of the earned income tax credit as a solution to the problem.
A tax rate structure like the one above would result in a reduction in total tax revenues of $397 billion, an effective overall tax cut of 13%, but it would also increase the amount of disposable income to those who earn $100,000 a year, or less, by $656 billion. That amount is equal to roughly 3.6% of current GDP levels suggesting such a tax structure would have a very dramatic positive impact on GDP growth rates.
Additionally, it would have a positive impact on the feedback loop that the wealthy depend on whether they realize it or not. The truth is, the ultra-wealthy - those whose wealth is largely derived through ownership of risk assets (primarily stock in their own company) - would find their wealth collapse if they ever attempted to convert those shares to cash. Another inconvenient truth - the total M2 money supply in the US is only 60% of the market cap of US publically traded stocks. In other words, there isn't enough money to allow those who own risk assets to go to cash. When you factor in the market value of the bond market, all real estate holdings, the value of privately owned companies, and the rest of those things we consider to be stores of wealth, it becomes glaringly obvious that the only way to preserve that wealth is to preserve the system - a system that in the past was driven by the working class consumption capacity.
Whether we want to accept the truth or not, Bernie Sanders is the only candidate whose policy position makes sense. He is spot on in stating that income and wealth disparity is part of the problem. The fact is simple, we do have two distinctly separate systems at work in our economy, the risk asset system, and the real economy system. And, the truth is that without growing demand, profits are not being re-injected into the economy, but rather leaving the real economy and moving into the risk asset economy - i.e., stock buybacks. That wreaks havoc on money velocity, and in so doing, breaks down the feedback loop that we depend on.
To restore that loop we need a progressive tax rate structure that starts from a rather severe negative rate at the low end. In other words, we end up using the IRS as a means of income re-distribution. Those who say that isn't fair are missing the point. If we don't maintain the feedback loop, those who have high wealth and high incomes will be hurt in nominal terms more than any other group. In an economy where demand for labor is at full capacity we don't need to worry about the feedback loop - it works because corporations return profits into the real economy in the way of wages, inventories, and capital expenditures. Where a labor glut exists, they simply buy their own stock back. The inconvenient truth is this - if the wealthy hope to retain their wealth, they need to think of ways to put money in the pockets of the working class. And, where a significant portion of the working class is idled, we need a different way to get that money into the hands of those who will send it right back to the people the government took it from in the first place under the progressive tax rate structure.
And, there is much more to be said about the effectiveness of deficit financed fiscal stimulus coupled with QE and ZIRP. Those who suggest it is unsustainable are simply wrong. Economic growth is a function of the supply of money, and that money's velocity. And, the inconvenient truth is that money is increased only through the process of borrowing it into existence. Those who suggest the federal government is so far in debt they will never be able to pay the debt off clearly don't understand how the system works. If it were possible to pay the debt off, we would end up with absolutely no money at all in the economy - none. Consider that M2 is roughly $12 trillion, and the Federal debt is fast approaching $19 trillion. If the government were to somehow get their hands on all the money in the economy they would still fall short of paying off the federal debt by $7 trillion. The idea that we should balance the budget, or that we should attempt to reduce debt levels is equivalent to saying we should deliberately destroy our economy, and that is a fact that those who understand the system simply cannot deny.
Bernie Sanders is the only one of the candidates that offers viable solutions to our dilemma. And, those who say his plans won't work are just plain wrong. Of course, overcoming the dogmatic mindsets of the people is the single biggest challenge to a full implementation of this new paradigm. I am reminded of my good friend Andy, an over the road truck driver who makes a very good living. He is fond of telling me that he "is tired of supporting all those people who sit on their couch watching TV and eating bonbons all day." Believe me, I get it. But, I wonder what Andy will say when Vactrain technology becomes reality and his own job is taken over as a result of technological advances.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.