While economic policy is largely used to address short-term imbalances (it is a rare “forward thinking” Central Banker, particularly a politically influenced one…), the side effects of such a policy approach is that it can upset the long term equilibrium of an economy, basically kicking the problems of today into tomorrow and the next generation (read – Europe!).
The current low interest environment has allowed equity holders and indebted banks to recover the huge losses accrued on the run up to the global systemic crisis but this comes with a heavy long term cost. This cost is income inequality.
Economic policy, in particular the one coming from central banks, has a strong redistribution effect, acting as an Anti-Robin Hood policy, stealing from the poor and giving to the richest.
In a recent study published by the US Employee Benefit Research Institute, one absolutely stunning revelation was made public: less than 36% of Americans have less than $1,000 in savings for retirement. That is a truly shocking number as it means that many Americans are destined to live out their days in penury or as a burden of future taxpayers. Either way it is a social disaster timebomb waiting to happen.
Unlike their parents and grand-parents, the youngsters of today in Europe and the U.S are underpaid and underemployed with many forced to take part-time jobs which aren’t even enough to pay their bills let alone put something aside for the future…
The stats breakdown as follows – among households earning up to $25,000, 75% have less than $1,000 saved for the future and 95% of these have less than $25,000. Among household’s earnings between $50,000 and $75,000, half have at least $25,000 put away and 20% saved at least $100,000. When it comes to the 6-figure group, 40% have saved at least $250,000 and the top 10% savers have at least $1,000,000 put aside.
The intuition behind all this isn’t rocket science. If what you earn isn’t enough to pay for your living expenses, you will end the month as a net borrower and not as a saver. This has strong implications for the future. Those unfortunate enough to be stuck on the lower ladder of the social hierarchy will either have to work until the grave beckons, or to a “food stamp” life soon after retirement. Economic policy in the U.S. should be concerned with this situation, as it will be the big issue of the future.
The following chart is a great tool for any policy maker aiming to improve the business cycle and address the inequality issue.
It tells a simple story. The more cash in hand a person has, the less they spend. The idea is that if you give $1 to someone who I not even able to face his or her living expenses, he will most likely spend every cent. If you instead give the same $1 to John Paulson, he will most likely save it, as his needs are mostly satisfied with the few million he takes home every month! So, in an economy which depends 90% on the marginal consumer, the best plan for its government is to give money to the poor, which are more likely to spend it. Maybe it’s time to dig out old Bernanke’s infamous “Helicopter drop” policy!!
Of course, Govt spending directed at a specific social class leans towards Marxist and Keynesian policies, but It not only makes sense in terms of economic growth but it also makes sense in terms of redistribution of income – something that is sorely needed in many Western economies today. Such redistribution would eventually decrease the marginal propensity to consume of the poor and thus lead them to save something for the future.
The next chart shows another important lesson for policy makers, especially those managing the money printers…
Having in mind what we gleaned from the first chart, it is time to look at ways of helping the economy and the poor at the same time. For the top 1% (the richest in the nation), the main asset they hold is business equity and then investments. Pensions, liquid assets and their homes aren’t that important in relative terms. But when we look at the 80% poor block, which is almost the entire population, business equity, and in particular investments, aren’t that meaningful. Their homes are their most important asset. For this group, what matters is to be able to pay their mortgages while keeping their homes. The majority of their earnings goes on keeping a roof over their head.
For a policy maker concerned with fine tuning the business cycle and also fighting inequality, it is obvious that targeting investments (equities) is the wrong route. You need to help the poor to keep their homes. Buying mortgage-backed securities to stabilise the market could make some sense, but if the primary side effect of the policy is to create an equity bubble, it doesn’t help the vast majority of the population. Hence why Q.E has been so good for the top 1% and disastrous for the bottom 80%. The poor in particular simply don’t hold shares, so it doesn’t help them. Of course you could say that if equities rise, then business could invest more and hire people, but that is an indirect effect. Why wait for indirect effects to (hopefully) take place when you have the tools to go straight to the issue? At the same time, what we have seen so far is that companies have been buying back shares and not exactly investing in CAPEX with the excess money. That is not job creation in our book.
A final note goes to the interest rate environment. Through keeping interest rates too low for too long, the FED is creating problems for savers, in particular for pension funds. The lower the interest rate, the higher the necessary contributions to keep the same level of spending in the future. That means that the FED is, in a perverse twist, making it increasingly difficult to save!
It is time to let interest rates rise to natural levels and use economic policy in a sound way. The economy depends on the majority but many economic decisions today are working against them. It reminds me of the moral hazard problems faced within a firm when control and ownership diverge. In the US economy the same is happening. Control and ownership aren’t in the same hands, which mean there is a huge moral hazard problem at the table to wrestle with.