Month: October 2013

The Fed takes middle-class to the cleaners

Posted on by j.giglio

Despite all the talk about the progress made over the last four years, the jobless recovery is eating away at the American economy like a swarm of termites invisibly consuming a house from the inside out, widening income inequality and undermining Americans’ belief in upward mobility.

The economic growth rate has fallen to less than 2 percent and the only reason the headline unemployment rate has declined to 7.3 percent is because so many people – especially middle and lower class Americans- have stopped looking for work or are working part-time. Job creation can’t even keep up with population-related growth in the labor force.

It is anticipated that under Janet Yellen, the likely successor to Federal Reserve Chair Ben Bernanke, current monetary policy will remain in place and the government will continue to pump trillions into the financial system, keeping interests rates near zero to offset the drag of current fiscal policy. When considering the feasibility of any future quantitative easing, government speak for printing money, the Fed would be wise to consider the policy’s adverse effects on savers and retirees and their interest income.

According to economics textbooks, reducing interest rates and the cost of credit is supposed to spur lending; encourage spending on big ticket items like cars and houses; and boost business investment in inventories, plant, equipment and hiring.

Sure, credit is the most important and most direct channel through which the Fed’s polices affect the economy, but the transmission lines through which cheap money flows are clogged. Despite sitting on an astonishing $2.3 trillion in capital available for lending, banks remain reluctant to extend credit to all but households with the highest credit scores. If you don’t need money, you can get all you want. And by dropping its short-term lending rate to near zero, the Fed allows banks to borrow, for example at 0.10 percent and invest the proceeds in Treasury bonds. Nobody in their right minds wants to own the 10- year Treasury bond at a 2.5 percent interest rate, but banks are doing it because they can borrow at nearly interest-free and earn a spread of 2.40 percent.

The good news is that the Fed’s policies have boosted the stock market. Chairman Bemanke has said that “higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

But while a rising stock market has helped market participants like financial institutions and large firms, it has done little to improve economic growth and reduce unemployment. The median amount of wealth middle-income families have is about $20,000. By contrast, the family that earns $90-$100,000 annually has about $424,000 in financial wealth.

The spoils of the recovery have not been equally shared. The boost in asset prices is likely to disproportionately benefit the wealthy and increase income inequality. Unemployment is still high by historical standards, economic growth is anemic, and real wages adjusted for inflation have not improved.

One of the overlooked consequences of the Fed’s rounds of monetary stimulus and reducing interest rates is to rob hardworking, average American savers and retirees of income and spending power, because the interest they earn on their savings isn’t enough to keep up with inflation. This dramatically reduces their spending, which hurts businesses, leaving them unable to hire. Consumer spending is critically important because it accounts for more than 60 percent of the nation’s gross domestic product.

But then who said the Fed was responsible for the equitable distribution of wealth, income or credit? After all, they have their hands full minimizing unemployment and inflation. Nowadays the average American doesn’t have much carry with a Fed whose policies are taking the middle class to the cleaners.

originally published: October 19, 2013

While America’s losses mount, the top 1% makes huge gains

Posted on by j.giglio

Several weeks ago, the Federal Reserve decided not to cut back, or taper as the finance mavens say, the billion-dollar bond buying program known as quantitative easing, which is a euphemism for printing money. A gradual reduction of QE had been expected since June, when Fed chairman Ben Bernanke said the economy was getting stronger and he might reduce the monthly purchases by the end of the year.

But the Fed got cold feet and changed its mind because its leaders don’t believe that economic activity and labor market conditions are strong enough to merit reducing the bond purchases. Economic growth is lackluster. The unemployment rate is too high, labor force participation is at a 34-year low and too many newly created jobs are low paying and/or part time. Consequently the Fed will continue buying $85 billion of Treasury and mortgage bonds each month and remain committed to holding short-term rates near zero at least so long as the unemployment rate remains above 6.5 percent.

So the training wheels stay on the bicycle and continue to feed an addiction to cheap money.

After five years of depending on a monthly injection of liquidity, it may well be that QE will become a permanent tool of the Fed for managing the business cycle and garden-variety recessions. Since it began in the Paleozoic era, circa late 2008, the Fed has hoped that QE would stimulate economic growth and hiring by holding down interest rates and encouraging households and businesses to spend and invest.

But given that the wealthy own a disproportionate amount of equities, the stock market’s gains are unequally distributed. While a rising stock market may make people feel wealthier, the run-up in their pension accounts -thanks to the stock market reaching new highs – does not send the average American running to the nearest retail store.

Corporations are using the record-low interest rates to take on new debt for acquisitions, increase dividends, and engage in share buybacks rather than investing in the real economy, which has certainly not helped the labor market. Of course, thanks to the Fed, the interest rate paid on the national debt is at a historic low of2.4 percent, according to the Congressional Budget Office. This keeps debt service costs down and understates the budget deficit.

The danger is that as everyone becomes addicted to cheap money, the Fed’s moves are setting the stage for a new bubble. Printing money floods the market with more dollars, which makes dollars worth less, which means that tangible assets priced in dollars, such as oil and food, end up costing more.

Prolonged low interest rates and an abundant money supply have punished savers and retirees. Their money has generated little return, which forces them into high-risk investments to try and keep up with inflation. The younger generation hurt by high unemployment is not increasing its consumption to make up for the decline in spending among older Americans. And as middle America struggles with rising food and gas prices, weighed down by high unemployment and stagnant wages, the gap between the wealthy and everyone else is growing.

While the question of whether the Fed’s monetary policy has helped the real economy and the average American remains unanswered, a new study from the University of California at Berkeley finds that the top 1 percent have captured 95 percent of the gains during the so-called recovery. Additionally, according to the Census Bureau, middle-class incomes have largely remained stagnant even after the recession ended. With high unemployment, corporations are under no pressure to increase workers’ mcomes.

The gap between the top 1 percent and the rest of the country is the greatest it has been since the 1920s. A large reason for this growing disparity is that the wealthiest households have benefited far more that ordinary Americans have from the Dow Jones Industrial Average more than doubling in value since it bottomed out in early 2009.

So much for the presumption that once the Great Recession ended, the American consumer would once again fuel economic growth.

originally published: October 5, 2013