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If Promoting Wealth Inequality and Social Breakdown Is Evil, The Fed Is Evil

President Reagan was widely mocked in America when he declared the Soviet Union an evil empire, but this calling things by their real name had a profound impact in the Eastern Bloc. The mockery stemmed from the secularized American view that there was precious little moral difference between the USSR and the US, that the USSR was a legitimate “alternative system,” and that ramping up Cold war tensions was not just dangerous but useless, as the USSR was as permanent (or more so) than the US.

None of which turned out to be true. While all nation-states harbor multitudes of sins, the Soviet Empire was unique in its mass suppression of basic human rights, its economic failure to better the lives of its imprisoned populations while its military might soared, and the perverse union of a Kafkaesque bureaucracy and an Orwellian propaganda machine epitomized by the old Soviet-era joke that “we pretend to work and they pretend to pay us.”

Fast-forward to today’s USA where soaring wealth and income inequality is making a social breakdown all but inevitable. Wages for the majority of households have gone nowhere for the past two decades, while the incomes of the top 5% have skyrocketed, with the majority of the gains flowing to the top 0.1%. (See charts below.)

History shows that fast-widening gaps between the super-wealthy / top 5% and the rest of the citizenry inevitably generate social disorder and breakdown. This dynamic is already painfully visible in rising homelessness, suicide rates, opioid addictions, burnout, intolerance, etc.

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The Doomsday Scenario for the Stock and Housing Bubbles

The Doomsday Scenario for the stock and housing bubbles is simple: the Fed’s magic fails. When dropping interest rates to zero and flooding the financial sector with loose money fail to ignite the economy and reflate the deflating bubbles, punters will realize the Fed’s magic only worked the first three times: three bubbles and the game is over.

So what happens when punters realize there won’t be a fourth bubble? They sell. Bids disappear because who’s dumb enough to bet (with Japan and Europe as lessons) that more liquidity and negative interest rates will magically work when zero interest rates didn’t move the needle?

Who’s foolish enough to catch the falling knife (i.e. buying plummeting assets on the way down) on the unsupported assumption that the next dose of Fed magic will reverse a bidless market?

And should the Fed start buying stocks, mortgages, housing and bonds to prop up those bidless markets, what’s the message it will be sending? Desperation.If the only buyer is the money-printing central bank, that’s pretty good evidence that your economy and markets are in free-fall.

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Here’s What We’ve Lost in the Past Decade

The past decade of “recovery” and “growth” has actually been a decade of catastrophic losses for our society and nation. Here’s a short list of what we’ve lost:

1. Functioning markets. Free markets discover price and assess risk. What passes for markets now are little more than signaling devices to convince us the economy is doing spectacularly well. It is doing spectacularly well, but only for the top .1% of 1% and the class of managerial/technocrat flunkies and apologists who serve the interests of the top .1%.

2. Genuine Virtue. Parading around a slogan or online accusation, “liking” others in whatever echo-chamber tribe the virtue-signaler is seeking validation in, and other cost-free gestures–now signals virtue. Genuine virtue–sacrificing the support of one’s tribe for principles that require skin in the game–has disappeared from the public sphere and the culture.

3. Civility. As Scientific American reported in its February issue (The Tribalism of Truth), the incentive structure of largely digital “tribes” rewards the most virulent, the most outrageous, the least reasonable and the most vindictive of the tribe with “likes” while offering little to no encouragement of restraint, caution, learning rather than shouting, etc.

The cost of gaining tribal encouragement is essentially zero, while the risk of ostracism from the tribe is high. In a society with so few positive social structures, the self-referentially toxic digital tribe may be the primary social structure for atomized “consumers” in a dysfunctional system dominated by a rigged “market” and a central state that no longer needs the consent of the governed.

Common ground, civility, the willingness to listen and learn–all lost.

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“Wealth Effect” = Widening Wealth Inequality

One of the core goals of the Federal Reserve’s monetary policies of the past 9 years is to generate the “wealth effect”: by pushing the valuations of stocks and bonds higher, American households will feel wealthier, and hence be more willing to borrow and spend, even if they didn’t actually reap any gains by selling stocks and bonds that gained value.

In other words, the mere perception of rising wealth is supposed to trigger a wave of renewed borrowing and spending.

This perception management only worked on the few households which owned enough of these assets to feel wealthier–the top 5%, the top 6 million out of 120 million households. This chart shows what happened as the Fed ceaselessly goosed financial assets higher over the past 9 years: the gains, real and perceived, only flowed to the top 5% of households earning in excess of $200,000 annually.

Spending by the bottom 95% has at best returned to the levels reached a decade ago in 2007.

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Observations on Wealth-Income Inequality (from Federal Reserve Reports)

To those of us nutty enough to pore over dozens of pages of data on wealth and income in the U.S., the Federal Reserve’s quarterly Z.1 reports and annual Survey of Consumer Finances (SCF) are treasure troves, as are I.R.S. tax and income reports.

Allow me to share a few observations on family wealth and income drawn from my review of these documents:

Changes in U.S. Family Finances from 2013 to 2016 (42 pages)

Financial Accounts of the United States (198 pages)

Corporate profits clock in at $2.135 trillion annually, around 11% of the nation’s GDP (gross domestic product). (Page 10 of Z.1) This has changed very little over the past few years; corporate profits totaled $2.140 trillion in 2014.

Most people who follow financial matters closely probably know corporate profits have been around $2 trillion annually for awhile.

But how many know that proprietors’ income from small businesses ($1.375 trillion) and rental income of persons–i.e. not corporations–($740 billion) together equal corporate profits? ($2.115 trillion for small biz/rentals, $2.135 trillion for corporate profits.

How many financially savvy people know that proprietors’ income and private rental income rose by $189 billion since 2014, while corporate profits flatlined?

Clearly, the families that own the proprietorships and rentals pulling down $2.1 trillion in annual profits are doing a bit better than OK.

As the charts below reveal, most of this profitable business equity is owned by the top 10% of families. There are a few clues that suggest that family-owned business equity is distributed along a power-law curve, i.e. a highly unequal distribution in which most of the wealth/income goes to the top few.

On Page 28 of the Survey of Consumer Finances (SCF), we find that the business equity owned by families in the bottom 50% of family incomes has a mean value of $208,000, up marginally from $204,000 in 2010, the business equity held by the top 10% of families rose from $2.265 million in 2010 to $3.3 million in 2016–a gain of over $1 million.

As always, I want to stress the profound difference between assets that produce no income and those that produce net income. This excludes hobby businesses that lose money or tax shelters that are intended to lose money. I’m talking about businesses that generate revenues in excess of all expenses: net profit that is taxable.

Owning a vacation home that is rented out a few weeks a year is one thing, owning a rental property that’s rented out 50 weeks a year is considerably different. The first is an expense, the second generates net income.

Somewhat to my surprise, almost 14% of households own some residential property equity other than their primary residence (page 18 of the SCF). Unfortunately, the Fed lumps second homes and vacation properties in with rental properties of up to 4 units, while rentals with 5 or more units are lumped in with farmland and commercial properties in equity in nonresidential property.

Only 6% of households own any equity in nonresidential property, a category of wealth that gained 72% from 2013 to 2016. Interestingly, the percentage of families owning this form of wealth actually declined from 7.2% in 2013 to 6.2% in 2016, suggesting to me that the corporations and hedge funds snapping up multi-unit residential properties are buying properties from families.

Based on my previous surveys of I.R.S. income tax data, much of this small-business equity and family owned-rental property is owned by the top 4% to 5% of families, with the majority owned by the top 10%, as shown in the chart below.

The number of families with business equity has been declining, eroded by recession and stagnation, despite the recent bounce higher.

Most of the biz-equity is owned by the top 10%:

While the financial media focuses on billionaires and hedge fund managers playing for billions, much of the wealth and income of the nation is firmly in the hands of families that own proprietorships and rental properties.

These assets have risen sharply in value, and they’ve also generated gains in income.

If you want to get rich, you can climb into a time machine, return to 2010 and buy a couple thousand bitcoin for $1 each. Alternatively, you can marry extremely well. If neither of these options is available, then starting a profitable proprietorship that enables the purchase of rental properties is another option. 

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

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The Fading Scent of the American Dream

It’s been 10 years since I devoted a week to the theme of The Rot Within(September 17, 2007). Back in 2007, I listed 16 systemic sources of rot in our society, politics and economy; none have been fixed. Instead, the gaping holes have been filled with Play-Do and hastily painted to create the illusion of shiny solidity.

We live in a simulacrum society in which the fading scent of the American Dream is more a collective memory kept alive for political purposes than a reality. Even more disturbing, the difference between a phantom prosperity (or in homage to the Blade Runner film series, shall we say a replicant prosperity?) and real prosperity has been blurred by layers of simulated signals of prosperity and subtexts that are carefully designed to harken back to a long-gone authentic prosperity.

This is the reality: the American Dream is now reserved for the top 0.5%, with some phantom shreds falling to the top 5% who are tasked with generating a credible illusion of prosperity for the bottom 95%. While questions about who is a replicant and who is real become increasingly difficult to answer in the films, the question about who still has access to the American Dream is starkly answered by this disturbing chart:

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What If the Tax Donkeys Rebel?

Since federal income taxes are in the spotlight, let’s ask a question that rarely (if ever) makes it into the public discussion: what if the tax donkeys who pay most of the tax rebel? There are several likely reasons why this question rarely arises.

1. Most commentators may not realize that the vast majority of income taxes are paid by the top 10%–and that roughly 60% are paid by the top 4% of households. (A nice example of the Pareto Distribution, i.e. the 80/20 rule, which can be extended to the 64/4 rule.)

As David Stockman noted in Trump’s 1,500-word Airball“Among the 148 million income tax filers, the bottom 53 million owed zero taxes in the most recent year (2014), and the bottom half (74 million) paid an aggregate total of just $45 billion. So let me be very clear. There was still $4 trillion left in the collective pockets of these 122 million taxpayers — even after the IRS had its way with them!

By contrast, the top 4% or 6.2 million filers paid $802 billion in Federal income taxes. That amounted to nearly 58% of total Federal income tax payments.”

2. Few commentators draw a distinction between earned income (wages and salaries)and unearned income (dividends, interest, and more broadly, rentier income streams from the ownership of productive assets.

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We’re Fragmenting Because our Experience of the Economy Is Fragmenting

You’ve probably seen some version of this chart of average household income in America before. (You may have seen charts of median household income as well; here’s an article on the difference between the two methods of measurement: American families are learning the difference between median and mean)

Here’s the data in table format, if you prefer: Household Income Quintiles.

The point is that there is an enormous difference between the average household incomes of the bottom 80% and the top 10%, 5% and 1%. It’s important to separate the various income brackets, as including the top households distorts the average. Here we see the average household income of the bottom 80% of households is around $50,000, while the average income of the top 10% (which includes the wealthy 1% and the super-wealthy .1%) is almost four times greater: $185,000.

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State of Denial: The Economy No Longer Works As It Did in the Past

If there is one reality that is denied or obscured by the Status Quo, it is that the economy no longer works as it did in the past. This is the fundamental economic context of our current slide into political-social disintegration.

The Status Quo narrative is: the policies that worked for the past 70 years are still working today. Boiled down to its Keynesian state-corporate essence, the Status Quo economic narrative is simple:

All we need to do to escape a “soft patch” (recession) is for governments to borrow and spend more money to temporarily boost incomes and demand until the private sector gets back on its feet and starts borrowing and spending more.

To help the private sector, central banks lower interest rates so it’s cheaper to borrow and spend.

As soon as the private-sector borrowing and spending rises, we can raise interest rates and trim state fiscal stimulus (i.e. governments borrowing and spending trillions more than they did before the recession).

But the inconvenient reality is these Keynesian policies no longer work. Fiscal stimulus (governments borrowing and spending trillions more than they did before the recession) has continued for a decade–or in Japan’s case, almost three decades.

The Keynesian gods have failed, but the worshippers of these false idols have no other form of black magic to turn to.

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Central Banks = Welfare for the Wealthy

The fact that central banks provide welfare for the wealthy is now entering the mainstream. The fact that all central bank policies since 2008 have dramatically increased wealth and income inequality is now grudgingly being accepted as reality by mainstream economists and the financial media.

The central banks’ PR facade of noble omniscience on behalf of the great unwashed masses has cracked wide open. Even The Wall Street Journal is publishing critiques of Federal Reserve policies that suggest the Fed has no idea how the U.S. economy actually works because their policies have failed to help the bottom 95%.

The grudging admission that central bank policies have enriched the rich while failing to benefit the bottom 95% is a breakthrough–the stone wall of denial has finally been pierced.

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The Deep State’s Catch-22

Catch-22 (from the 1961 novel set in World War II Catch-22) has several shades of meaning (bureaucratic absurdity, for example), but at heart it is a self-referential paradox: you must be insane to be excused from flying your mission, but requesting to be excused by reason of insanity proves you’re sane.

The Deep State in virtually every major nation-state is facing a form of Catch-22: the Deep State needs the nation-state to feed on and support its power, and the nation-state requires stability above all else to survive the vagaries of history.

The only possible output of extreme wealth inequality is social and economic instability.

The financial elites of the Deep State (and of the nation-state that the Deep State rules) generate wealth inequality and thus instability by their very existence, i.e. the very concentration of wealth and power that defines the elite.

So the only way to insure stability is to dissipate the concentrated wealth and power of the financial Deep State. This is the Deep State’s Catch-22.

What happens when extremes of wealth/power inequality have been reached? Depressions, revolutions, wars and the dissolution of empires. Extremes of wealth/power inequality generate political, social and economic instability which then destabilize the regime.

Ironically, elites try to solve this dilemma by becoming more autocratic and repressing whatever factions they see as the source of instability.

The irony is they themselves are the source of instability.

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What Does It take to Be Upper Middle Class?

What does it take to be upper middle class? According to one analyst, the answer is: at least $100,000 a year for a family of three. The Growing Size and Incomes of the Upper Middle Class (Urban Institute).

The paper claims the upper middle class has grown from 12.9% of the population in 1979 to 29.4% in 2014–in essence, the shrinkage of the “middle class” is not just from households dropping down the ladder but millions of households climbing up to the upper middle class.

Not Just the 1%: The Upper Middle Class Is Larger and Richer Than Ever (WSJ.com)

While the evidence broadly supports this secular shift–the concentration of income and wealth in the top 20% increases while the wealth and income of the bottom 80% stagnates–I think the claim that 30% of all U.S. households are upper middle class grossly overstates the reality, which is it’s become increasingly costly to even qualify as middle class, never mind upper middle class.

I’ve explored these topics in depth over the past few years:

How Many Slots Are Open in the Upper Middle Class? Not As Many As You Might Think(March 30, 2015)

What Does It Take To Be Middle Class? (December 5, 2013)

If we measure financial characteristics of middle class status rather than income, we find $100,000 is borderline middle class, not upper middle class.The above essay lists the baseline of 10 minimum metrics of middle class status. In high-cost regions, $100,000 barely qualifies a household as middle class; to be upper middle class, households must earn closer to $200,000.

A household income of $190,000 is in the top 5% nationally. According to the Social Security Administration data for 2013 (the latest data available), individuals who earn $125,000 or more are in the top 5% of all earners. Two such workers would earn $250,000 together. The 2.8 million households with incomes of $250,000 or more are in the top 2.5%.

I think it is reasonable to define the 12% of households earning between $125,000 (top 15%) and $350,000 (the cut-off for the top 1%) as upper middle class. This is around 14.5 million households, out of a total of 121 million households.

This is a far cry from 30% of all households qualifying as upper middle class.What we’re seeing is the inflation of “middle class” to “upper middle class,” just as a B grade is now an A, and jobs that don’t require a university degree now nominally require a bachelors degree or higher.

The increasingly desperate effort to reach the upper middle class is evidenced by a slew of books and articles on what it takes to succeed in an increasingly winners-take-all economy, and on the anxieties of those trying to “make it”: note that most of the articles are published in magazines/media outlets that appeal to the very upper middle class that’s anxious about maintaining their tenuous hold on prosperity:

How to Save Like the Rich and the Upper Middle Class (Hint: It’s Not With Your House) (WSJ.com)

The Hidden Cost for Stay-At-Home American Parents (Bloomberg)

The War on Stupid People: American society increasingly mistakes intelligence for human worth (The Atlantic)

The Limits of “Grit” (New Yorker)

The Talent Code: Greatness Isn’t Born. It’s Grown. Here’s How. (via Ron G.)

The Geography of Genius: A Search for the World’s Most Creative Places from Ancient Athens to Silicon Valley (via Ron G.)

Grit: The Power of Passion and Perseverance (book)

I’ve laid out my own bootstrap blueprint in Get a Job, Build a Real Career and Defy a Bewildering Economy (hint: don’t cling to credentials and privilege as your strategy–acquire skills and entrepreneurial income streams).

What’s left unsaid in all these articles is much of the upper middle class is prospering due to privileged positions that are increasingly at risk of disruption–a topic I discussed in If You Want More Jobs and More Job Stability, Disrupt More, Not Less (June 21, 2016) and How Many Law Schools Need to Close? Plenty (June 20, 2016).

And just a reminder: of the supposed 30% of households who are upper middle class, only the top 10% have significant wealth-building assets: that tells us in no uncertain terms that two-thirds of the supposedly upper middle class 30% are only middle class.

A Radically Beneficial World: Automation, Technology and Creating Jobs for All is now available as an Audible audio book.

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