A Fish Rots from the Head

Written by Scott Baker

The official numbers for inflation – PCE (Personal Consumption Expenditures Price Index) – present a case for low inflation and low inflationary pressure. (See Figure 1.) Wage and income inflation – represented by median household income – is disinflationary, and since the turn of the century even deflationary. (See Figure 2.) The expansionary monetary policy of the Federal Reserve is based on the perception that the policy is justified by low employment levels and the above measurements of inflation. But what if the Fed is looking at the wrong metrics?

Figure 1 – Click for a larger image

Figure 2 – Click for a larger image

I believe a clear case can be made that asset inflation is causing inflation at the top, even as the bottom 80% of the population has not seen an inflation adjusted raise in approximately 40 years, and the next 19% has only seen a modest real raise. It’s the 1% and even the top 0.1% whose income has soared. Their “surplus” is not just in assets that most Americans don’t own, like stocks and bonds, but also in hard assets, like land. Blackrock is now the country’s largest land owner, with former mortgage defaulters going on to rent homes they used to have equity in (obviously, not enough). The ultra low interest rates enable institutional borrowers, who use enormous amounts of leverage (again) to buy up hard assets and then profit from the “rent” on them, and to pay off the loans too. This game can continue until the Fed finally raises rates. It is so precarious and such a “heroin fix” that the Fed will forestall that day as long as possible, in my opinion, hoping that somehow businesses will start producing organic growth and profits outside of the QE injections.

However, there are multiple reasons why this is unlikely, including the 91% of profits being plowed into stock buybacks and dividends. Says Prof. William Lazonick in the Harvard Business Review cites “an unprecedented amount of debt being incurred to support this habit which only benefits shareholders“.

It used to be that companies spent most of their profits on R&D and growth. No more. Of course, if businesses don’t grow, they can’t hire. If businesses can’t hire, or increase wages, then workers won’t be able to spend or pay down debt. The whole thing will grind to a halt once the Fed removes QE and ultra-low interest rates…unless the foreign buyers pick up the slack in buying USTs to keep the dollar artificially strong so that their exports are cheaper here.

How long can that go on when we are imposing sanctions, committing hostile acts towards everyone, and getting Europe to do the same, causing it to return to recession? Jared Bernstein writes in The New York Times that we can no longer afford to support the world’s reserve currency, the U.S. dollar:

But new research reveals that what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles. To get the American economy on track, the government needs to drop its commitment to maintaining the dollar’s reserve-currency status.

The position as the world’s reserve currency artificially increases the value of the U.S. dollar – exporting nations manipulate their currencies for favorable exchange rates relative to the reserve. While reserve currency status is a favorable condition for capital held in that currency, it is disadvantageous to workers who lose in competitiveness when the advantage earned by the capital is extracted for short-term gain rather than invested for long-term advantage. Furthermore, the foreign countries holding our Treasuries are in effect being subsidized by U.S. Taxpayers who are paying the interest on those bonds, so that they (e.g. China) do not have to tax their own citizens instead. In short, we are paying the Chinese to sell us cheap goods that take away our jobs.

As the head of the fish loads up on fat (inflation of assets), circulation to the rest of the body (which is where the heart and lungs are) is being choked off. Without that critical circulation can there be sustainability? Or as the head starts to decay in its own putridity, does the starving body have any choice but to follow into decay of the entire system?

There is an alternative to top-nowhere (i.e. nonfunctional top-down) policies: direct injection of money to the bottom 80%. Says Mark Blyth and Eric Lonergan in a recent issue of Foreign Affairs magazine, in their article “Print less but transfer more“:

Rather than trying to spur private-sector spending through asset purchases or interest-rate changes, central banks, such as the Fed, should hand consumers cash directly. In practice, this policy could take the form of giving central banks the ability to hand their countries’ tax-paying households a certain amount of money. The government could distribute cash equally to all households or, even better, aim for the bottom 80 percent of households in terms of income. Targeting those who earn the least would have two primary benefits. For one thing, lower-income households are more prone to consume, so they would provide a greater boost to spending. For another, the policy would offset rising income inequality.

This would certainly achieve the goals mentioned by the authors, but it would still increase the debt, thereby enriching still more the banks and other institutions (including foreign ones) that hold the Treasuries used to create the dollars for that bottom 80% to spend while consuming. This seems to be robbing Peter to pay Midas. Perhaps there is a better way to get money to those who need it and spend it into the economy, thereby creating jobs by increasing demand? One way would be for Treasury, with the approval of Congress, to create debt-free money, as allowed for in the Constitution’s Coinage Clause (Article 1, Section 8, Clause 5 allows Congress to “coin Money“). This was most famously done by president Lincoln during the Civil War, three times, totaling $450 million, making up to 40% of the Federal Budget at its peak issuance. These United States Notes were in production until 1971, and about $250 million remain in circulation, mostly among collectors (they actually sell for about twice face value, due to their scarcity).

How quickly would the recession that so many Americans feel has never ended, actually end for them, if every man, woman and child were to receive a $12,000 check, perhaps spread over 12 months, as stimulus? True, this is almost by definition, partly inflationary, though not as much as people might think, because of the demand-driven economic expansion that would surely follow. But, in any case, we can tax inflation away. We know where the fat is; it’s in the fish’s head.