Wednesday, November 04, 2015

Wall Street's Plundering of America

There has been a lot of discussion over many years about the decline of the American middle class. That’s because the process has been decades in the making.

But a closer look reveals a broader economic decline, involving almost all Americans, from all classes.

The stagnation of incomes and wages isn’t merely a recent phenomena. When adjusted for inflation, both have suffered a long term decline.

A new report by the Social Security Administration has some rather stunning findings.

In 2014, 38% of all American workers made less than $20,000; 51% made less than $30,000; 63% made less than $40,000; and 72% made less than $50,000.

Put another way, if you make more than $30,000, you earn more than 51% of Americans. And if you make more than $50,000, you earn more than 72% of Americans.

That is simply breath-taking, and it doesn’t square with the notion that America is a prosperous society where anyone can get ahead with some hard work and discipline.

In fact, the U.S. dropped out of the top 10 and into 11th place in the 2015 Legatum Institute Prosperity Index, which measures economy, education, entrepreneurship & opportunity, governance, personal freedom, social capital, health and safety.

If you’re still recovering after digesting those depressing findings from the Social Security Administration, get ready to be shocked again.

In September the US Census Bureau released its report on US household income by quintile. The findings are brutal.

Every quintile (or 20% share), as well as the top 5%, has experienced a decline in real household income since their peaks.

The bottom quintile (the lowest 20 percent) has experienced a 17.1% decline in real income from the 1999 peak (from $14,092 to $11,676). The 4th quintile has had a 10.8% fall in real income since 2000 (from $34,863 to $31,087). The middle quintile has had a 6.9% decline in real income since 2000 (from $58,058 to $54,041). The 2nd quintile has had a 2.8% fall in real income since 2007 (from $90,331 to $87,834). The top quintile has had a decline in real income since 2006 of 1.7% (from $197,466 to $194,053). The top 5% has experienced a 4.8% reduction in real income since 2006 (from $349,215 to $332,347). Only the top One Percent or less (mainly the 0.1%) has experienced growth in income and wealth.

Meanwhile, the US stock markets are still flirting with their all-time highs. Quite a disconnect, huh?

Many American corporations have been actively buying up their own shares with the use of very cheap money — the result of the Fed’s zero-interest-rate policy.

However, stock buy backs are just gimmicks to improve share prices. They don’t actually improve business, and they aren’t a productive use of capital. Stock buy backs may increase earnings per share, but they don't increase earnings. Fewer outstanding shares doesn’t help the bottom line.

Likewise, a company can trim costs (such as personnel) without actually increasing revenues. Ultimately, profits may increase for a while, but there are limits to cost cutting. If revenues aren’t growing, then neither is the company.

The use of stock buybacks and similar gimmicks amount to nothing more than smoke and mirrors.

Corporations engage in such shenanigans as a means of increasing earnings per share, which pleases Wall Street. And, as we all know, what Wall Street wants, Wall Street gets.

Companies will engage in unsustainable practices just to improve their stock price and/or earnings per share in an effort to satisfy the Street.

All focus is on the short term. Live for today, and don’t worry about tomorrow. More precisely, it’s live for this quarter — don’t worry about anything that comes after. There is no concern for the long term.

Wall Street’s takeover of the economy is what is known as “financialization.”

Over the last 35 years, or so, the financial sector has become more important than the industrial and agricultural economies — the sectors that actually produce tangible things. Leverage (debt) has taken precedence over capital, or equity.

Finance is not a productive activity. It is extractive, robbing from the economy. Nothing is created, other than debt.

Joan McCullough, of Longford Associates, sums it up quite nicely in her recent piece, The Financialization of the Economy.

Financialization is characterized by the accrual of profits primarily thru financial channels (allocating or exchanging capital in anticipation of interest, divvies or capital gains) as opposed to accrual of profits thru trade and the production of goods/services.

Economic activity can be “creative” or “distributive.” The former is self- explanatory, i.e., something is produced/created. The latter pretty much simply defines money changing hands… Financialization is viewed as largely distributive.

Business (and government) does the bidding of its financial masters on Wall Street. And Wall Street’s game is pumping out debt, which hangs like a grotesquely outsized albatross around the neck of our economy.

With the Federal Reserve keeping its benchmark at near-zero for the last seven years, companies have loaded up on debt.

“They now owe more in interest than they ever have, while their ability to service what they owe, a metric called interest coverage, is at its lowest since 2009,” notes Bloomberg.

As of the second quarter, high-grade companies tracked by JPMorgan incurred $119 billion in interest expenses over the last year, the most for data going back to 2000, according to the bank’s analysts. Companies have already issued $9.3 trillion in new debt since the financial crisis.

That’s a big hinderance to economic growth.

As the IMF notes, “the marginal effect of financial depth on output growth becomes negative … when credit to the private sector reaches 80-100% of GDP …”

In other words, too much financialization restricts growth.

We’ve long since surpassed that critical threshold. As of 2014, the US ratio of private sector debt to GDP stood at 194.8.

Making money out of money creates nothing.

“By creating nothing, the economy relies on the financialization process to create growth,” writes McCullough. “But the evidence supports the notion that once overdone, financialization stymies growth.”

However, as we all know, debt is not just corporate America’s problem.

The federal government owes over $18.4 trillion in debt (not including trillions more in unfunded liabilities), and the 50 states have a collective debt of over $5 trillion.

Then there’s the debt of ordinary Americans. As of June 30, total household debt was $11.85 trillion — 6.5% below its third quarter 2008 peak of $12.68 trillion, according the the New York Fed. Despite the improvement, Americans are still heavily indebted — or, more accurately, over-indebted.

The point that I’ve made many times through the years is that Americans are tapped out. Despite their shrinking wages and incomes, Americans don’t want to take on further debt. Diminished incomes and large debts have only served to shrink demand and diminish consumption.

Without adequate demand and consumption, business slows, as does investment. In the long run, job creation will be negatively affected as well.

Now the economy just hobbles along, a shadow of its former self. The days of 3,3% annual economic growth (our historic average) are a thing of the past. In fact, the economy hasn’t surpassed 3% annual growth since 2005.

This is our reality. This is what financialization has done to us. It has squeezed and siphoned from the economy. It is leaving a ravaged carcass, as it eats all the meat from our economic bones.

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