The "Economic Expansion" that Wasn't

Census bureau reported yesterday that the median household income rose in 2006 by 0.7%. This sounds like good news, but it isn't. When you look more closely at the numbers, there are some disturbing trends:

• The earnings of men and women working full time actually fell by 1%.
• The increase in household earnings was due, apparently, to having more family members working.
• The median income of working-age households (those headed by someone less than 65 years old) is lower by 2% than what it was in 2000, the year before the last recession.
• The only group whose income in 2006 exceeded their income in 2000 were the those in the top 5%; for everybody else, incomes were lower.
  
• Despite a small improvement in the poverty rate, 5 million more Americans were living in poverty than 6 years earlier.
• The GINI coefficient, the standard measure of income inequality reached .47, a number approaching third world levels. (The the higher the number, the greater the level of income inequality. The U.S. has the highest level in the industrialized world.)

But the worst part is that, as the New York Times reported, this is as good as its going to get for some time. The economic party is over, "and most working Americans never got near the punch bowl." The rewards went to those at the top. How did this happen? Simple. The expansion wasn't really an expansion at all. A real expansion is when you increase the output of goods and services AND provide the income to purchase them. But what actually happened is that we increased our imports of goods and services, and financed their purchase with credit. This mimics an expansion, but isn't actually one; its just living on credit cards. People maxed out their lines of credit, both with plastic and by re-financing their homes to convert the equity to spendable cash. But in truth, a nation can only produce its way to real wealth; it cannot borrow to become rich.

We are creating a two-tiered society, a society of the type more commonly seen in undeveloped and economically backward countries. The United States lives on the generosity of foreign lenders, a situation that can not be indefinitely prolonged. Of course, this is bad for working people, but its not even good for investors. Why? When you have an increasingly large concentration of wealth at the top, you suffer a loss of purchasing power at the middle and lower ends of the economic spectrum. But a healthy market depends on the majority of the people having enough income to "clear the markets," that is, to purchase all the goods and services. But our middle and lower income groups can no longer do this. This means that there are fewer good investment opportunities, but a larger amount of wealth chasing them. And, by the laws of supply and demand, the price of good investments rises, and the yield falls. This means it gets harder and harder to find good investments and decent returns.

The problem can be solved temporarily by having those with excess incomes lend to those with deficient incomes. This keeps up demand, but only delays the problem and in fact makes it worse with each passing day. The high rates of interest for consumer loans means that even more wealth gets transferred to the top, which further shrinks the market, which further makes getting a good return difficult, and which forces investors to grant more consumer loans. When you finance an economy on credit cards, you set up a house of cards that must collapse.

The problem for investors is that as yields fall, risk premiums get flattened or disappear entirely. That is, a dubious loan pays little more than a good loan. But while risk premiums may disappear, risk does not. Loans go bad and lenders go broke. And when they do, the assets underneath the loans come to market at the same time, meaning there are excess inventories, which drives down the price of all other assets, making all other loans less secure (it gets complex, doesn't it?)

A two-tiered market is the sign of an economy in decline. For the last five years, this economy has benefited from enormous amounts of fiscal stimulus: tax cuts, high deficits, foreign borrowing, consumer loans, all count as stimulus. Yet despite such hugh amounts of money being pumped into the economy, the results have been comparitively anemic. Now they may be coming to an end entirely.