Global Economic Instability:
Wealth Inequality, Depressions and Recent Crisis


Home Page:
Year 2000 Economics
by Daniel

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An unregulated global economy dominated by corporations that recognize money as their only value is inherently unstable, egregiously unequal, destructive of markets, democracy, and life, and is impoverishing humanity in real terms even as it enriches a few in financial terms.

In order to understand the current global economic crisis we must look at the history of the past 30-50 years and how wealth inequality, world trade and debt relate and fit the big picture.

The U.S. of the past 50 years can be likened to the core of an empire; in this case a business empire. Peripheries of this American Empire in the post WWII era would be Germany, Japan, parts of Europe, Asia and South America. At the rise of this empire (1945-early 1970's), the periphery countries gather economic momentum which, as time goes by, accelerates at the expense of the core. These satelite nations become dependent on the empire to sell their goods, which in turn are traded for its currency ($US) which is then re-invested to produce even more goods for exports.

Fierce competition and proliferation of consumer goods from the satelite nations causes high-wage paying industries in the core to cut back as traditional industries (steel, autos) succumb to global pressures with losses of high paying jobs. As the economy of the core transforms, lost jobs are then replaced with sub-standard, low wage jobs (services). The loss of buying power of the now shrinking middle-class grows and the poverty rate increases with each passing year, with a loss of real wages, disposable income declines and stagnates.

Expecting a constant rise in the standard of living, consumers begin to borrow on credit through credit cards, equity loans and extended car loans to maintain the status quo they've come to expect during the high. With productivity and real taxable income begining to shrink, government spending continues to climb as before, creating cumlative deficits. This creates a demand for credit and debt which can only be met by the affluent, and most importantly, capital accumulated ($US) by the peripheries (e.g. Japan) from imbalanced trade deficits with the core. In other words, high demand for credit raises real interest rates in the debtor nation, thereby attracting surplus foriegn capital. In effect, the core becomes an exporter of money as the peripheries export goods, to which the proceeds are used to finance American debt.

This cycle continues unabated until there is an extreme imbalance in the distribution in income and wealth, also fueled by mis-guided tax policies. Middle-class consumers, unwilling to reduce their expenditures to match their falling incomes, borrow heavier and heavier creating further transfer of wealth to the affluent in the form of interest payments. With so much capital in the hands of the few, it is socked away in speculative investments as the stock markets, creating a bubble (1982 to present, especially 1995-on). As the bubble grows it attracts ever-more average people who would otherwise save. This then creates a "wealth effect" where people feel richer and correspondingly spend more, which keeps the bubble economy accelerating in the core of the empire. Eventually the unfortunate bottom 80% become so indebted and over-extended their actual net worth becomes nothing, and the net savings rate becomes nil. Unable to borrow any further, spending becomes stretched as oversupply in durable goods permeates world markets. Satelite exporter countries, having an oversupply of capital and goods, begin to collapse in a deflationary spiral as the core can no longer absorb the glut.

In the final stage of the empire, the core is able to hang on until the last minute even while its peripheries' bubble markets and economies burst. In this brave new world of unregulated currency flows, capital flees toward the core, further increasing the speculative bubble. This is where we stood in late 1998 with much of the world collapsing with Asia in deflationary crisis, Russia, Latin America and Brazil's financial system falling apart, and America holding on. The expansion continues even further, and stops the dominoes from falling further (witness stabilization after fall 1998) and aids a world-wide recovery.

Finally, the core of the empire becomes over-extended and imbalanced, overloaded with debt at all levels. When the economy begins to slow, the structural weakness becomes evident as it enters a deflationary spiral. Burdened by a historically extreme credit bubble, it can no longer grow its economy with satelite surplus capital, increased debt loads (let alone service the existing debt), and effectively begins defaulting, with bubbles bursting, and consumers stop spending and begin saving again, further contributing to the collapse.

The empire's core, unable to withstand the financial strain of collapse, comes crashing down, bringing the peripheries and much of the global economy and international division of labor with it.

Conclusion: The American Global Business Empire, Based on many decades of unregulated liassez-faire capitalism--actually ruled by crony capitalism and central banks, is at risk of collapsing in a fashion similar to 1929-1933, even as the USSR communist empire within the coming years. We can pretty much be confidant that our current socio-economic system will not survive its present form much longer, resulting in societal transformation, series of crises and conceivably, ultimately, World War Three .

Capitalism, the triumphant economic system of the last two hundred years, has effeciently produced the most affluent economies on earth. It tends to mirror the "strong survive" of nature and follows in rythyms and cycles of boom & bust. It has been transformed and modified throughout recent times to produce various forms of socialism and combinations thereof. We've seen the collapse of communism, fascism and current-style socialism on the wane. From the view of 1990's, it would seem that capitalism emerged the winner. Or is it ready to collapse as well?

Free market capitalism has it benefits and flaws. It tends to be de-humanizing , unstable, destructive and creates extreme wealth disparity when controls are absent. Most democracies have added social safety nets in the twentieth century (which are now being dismantled) to ease the suffering of those on the lower end, or controls on finance like the Federal reserve or FDIC. Capitalism is not perfect , of course, and tends to result in imbalanced excesses which must be corrected through a severe economic decline such as a depression and market collapse.

The biggest event to challenge to capitalism was the 1930's Great Depression. While scholars still tend to disagree on the causes, it be shown (as on this page) that long-term structural imbalances require a near (or total) collapse for a new order to be re-born from the old. Over time the degree of each depression becomes magnified and ratcheted up in intensity.

Moving on to the more serious flaws of late 20th century capitalism and the destablizing effect it creates. Below is further in-depth study, graphs and statistics of the concept this thesis shows:

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WEALTH INEQUALITY and CONSUMER DEBT:
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Disparity of wealth is natural in most economies and certainly in the U.S. There is nothing wrong with some owning more than others, and is probably healthy for economic development and progress. However, in cetain eras it becomes extreme and unhealthy as it fractures the social-economic landscape, Eventually (if allowed to continue) it will result in a revolution, or in the case of 1920's America, a depression.

The US of 1920-1929 is strikingly similar to 1990-1999. In fact, disparity in wealth exceeds that of 1929. As well, the stock market is in a speculative bubble, consumer debt far exceeds 1929 levels, and economists are declaring the fundamentals "sound". What followed was an unprecedented depression which equalized financial wealth, paving the way for a long-term boom in productivity, affluence and a tide that "lifted all boats". From WWII to about 1973, wealth inequality remained stable, then widened sharply thereafter. Now, the 1990's story mirrors that of 70 years ago, only worse.

OWNERSHIP OF NET FINANCIAL WEALTH.

As a result, of the total financial wealth in U.S. households at the beginning of the '90s, the richest 1% of the households owned 48% of it, the next richest 19% owned 46% of it, and the bottom 80% owned 6% of it. (Source: Wolff, '95) Put another way, the top 20% own virtually all net wealth, with the top 1% owning more than the combined wealth of the bottom 90%

At the same time as these trends grew, they were fueled by a reduction in the top marginal tax rate under the Reagan Administration in the 1980's. This was done under the noble but misguided policy of Supply-side Economics. The theory was to put more money in the hand of the rich, which would then be invested in industry thereby creating jobs for the poor in a "trickle-down" manner.

The eventual result was record speculation and corporate take-overs which made the 1980's famous for. This has, of course, continued well into the 1990's and is at an all-time high.

INCOME INEQUALITY:

Average weekly earnings of nonsupervisory workers, total private industry, 1982 dollars4

1965  $290 
1970   297 
1973   315  (Peak)
1975   292  
1976   297
1977   299
1978   301
1979   291
1980   274
1981   271
1982   267
1983   272
1984   274
1985   271
1986   271
1987   269
1988   266
1989   263
1990   259
1991   255 
1992   255  (Nadir)

While executive salaries skyrocketed:

Income Bracket       Percent Increase
$20,000 - 50,000          44%
200,000 - 1 million      697
Over $1 million        2,184

Or put another way:

Level of gains made for each income percentile from 1979-1993

Or another way:

The left chart shows household debt as a share of national income from 1963-1996.

Note the left side of the chart - - showing the household debt ratio was declining before 1970 - which means household debt was growing slower than growth of the total economy.

We recall from the above charts that prior to 1970 family incomes were rising - but thereafter growth stopped for the following 25 years.

The left chart shows at the same time family incomes stopped rising (1970) that household debt ratios stopped declining (at 53% of national income), then started upward, slowly - and then took off upward like a rocket - - to a historic record high debt in 1996 (at 89% of national income).

Since household debt has risen at rates 70% faster than growth of the economy since the late 1960s when real median family incomes stopped rising, such suggests real equity & savings are not the driving force of economic size - - it is all debt driven.

This is an indicator of how families try to maintain their apparent living standards and consumption ("keeping up with the Jones' with no income growth to do so). They compensate for stagnant incomes by rapidly expanding credit - - credit cards and later the more dangerous form of credit for consumption being home equity loan financing of household consumption. At the same time that families face less social security/medicare benefits when they retire (than their elders), many head toward their golden years more and more in debt with lower home equity (than their elders).

If the 1996 debt ratio had been the same as in the 1960s, then 1996 debt in dollars would have been $2.1 Trillion less than it was. In other words, the 1996 household debt would have been $3.3 Trillion - - not the $5.4 Trillion that did occur.

This shows that the economy is more leveraged by household debt than ever before. And, households are even more at the mercy of credit availability and interest rates.

This chart may understate the rising debt impact on families, since it shows debt ratios for all households - - including seniors. If senior households were removed most likely the upward slope of family-only debt ratios would appear even steeper.

chart So as families spend more and purchase on credit, they also save less. America used to save 10% of its income. This would enable extra capital to be used for investments by business. This capital is now supplied by foriegners as shown in the trade section below. As this chart shows, consumers have reduced their savings rate dramatically, and according to the latested data, is actually negative! The lowest in 70 years! Obviously this will not continue for very long.

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FOREIGN TRADE DEFICITS:

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chart The United States has gone from creditor to debtor status in the past few decades. As its periphery countries where rebuilt following World War II, the core benefited as it remained intact from battle damage. As it builds up the economies of Japan and Germany (and others), it plants the seeds of its demise as it allows unfetered flow of goods from these highly competitive nations, which elbow out traditional U.S. industry. Most striking is its relationship with Japan. As high paying steel, automobile, electronics and computer industrial production is cut back, high wage, middle-class jobs are eliminated. chart From 1945 to 1966 Japan actually ran small deficits with the US as it's economy grew by leaps and bounds as it follows a feircely competitive industrial plan which began under the marshall plan. After many years of staggering trade surplusses with the U.S. core, great amounts of capital are accumulated . This created a speculative bubble which burst in 1990. With its economy under-performing, this surpluss capital finds its way into the still booming U.S. economy and stock market, creating a speculative bubble. chart The left chart shows the trend of our cumulative international Current Account deficits. As we purchase more from foreign nations than they from us, and as their investment income from their US investments (including interest they earn on their ownership of many of U.S. Treasury bonds) grows faster than ours invested in their nations, we owe them the difference. The Current Account is the broadest gauge of the country's trade performance, because it not only measures trade in goods and services, but also investment flows between nations.

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Government Debt
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foreign share,debt What do foreigners do with all that cash they earn from our massive international trade deficits, as shown in the Trade section above? They use some of it to buy up liens ('mortgages') against our national government, by purchasing outstanding Treasury bonds and notes - - which we issue as debt securities to gain cash to cover our internal debt caused by excessive federal government spending. We like their money. We spend it, and place ourselves increasingly in debt to them. The total federal debt is about $5.4 Trillion. Of this amount, approximately $3.5 Trillion in federal debt IOUs are owned by and payable to what the Federal Reserve calls the 'public,' from whom the federal government borrowed. But, the 'public' does not mean only U.S. citizens - - it means anyone in the world who owns those IOUs and the principal and interest pertaining to same. chart The chart at the left shows that, according to Federal Reserve data for August 1997, $1.3 trillion of this debt, or 38% of same is owed to foreign interests - - not to U.S. citizens. Note the rapidly rising trend in the past several years, as foreign holdings zoomed upward during the 1990s.

The chart bellow shows the 67-year trend of federal government debt, in current dollars without any adjustments. One thing most interesting about this chart is that none of the data is adjusted for inflation or growth of the economy, so the plot is free of distorting adjustments, and therefore lays bare revealing information. In this period, it started at $16 Billion. By 1997 it was 344 times larger, rising exponentially to $5.5 Trillion. Looking at the left side of the chart you will see the jump in the early 1940s, due to World War II. From that point forward, the curve remains relatively flat (at a low level of about $250 billion) for the next 20 years, despite growth of the economy. This was a period of strong real growth in median debt family incomes, a period when for most families only one wage-earner per household was needed to expand living standards. Starting late 1960s, an upward trend emerged, then accelerating in the early 1970s. [it is interesting that since the start of the rise in debt, the Family Income Report shows incomes (adjusted for inflation) ceased rising (for the next 2 decades)- and real incomes fell for full-time employed male workers.]

How can interest rates be so relatively low in the U.S. when the household savings rate is effectively less than zero, and consumers spend like crazy? For one, the immense tax inflows of past years, a result of a booming economy (not the Clinton administration), have eliminated the federal government deficits that plagued us since the eighties and has off-set this net savings short-fall, at least in terms of the national economy. Second, hundreds of billions of dollars have flowed in from overseas--the result of record breaking U.S. trade deficits, filling the demand for savings. Thirdly, as previously mentioned, the stock market has lately replaced traditional vehicles of saving and has the effect giving a misleading picture when one looks at the official data and charts; when the realized capital gains reported to the IRS are accounted for, we arrive at a household savings rate of around 10% ...where it has been historically.

This situation is dangerous and cannot and will not continue forever and thus can expect a volatile and disastrous environment in 2000 as world trade is seriously disrupted in 2000 and beyond. At some point consumers will retrench and begin saving again, as they always do in a recession . An action that would throw the economy into a tailspin. It is likely--if the computerized global financial trading system can weather the onslaught of glitches--that investors will, by their actions and loss of confidence in the midst of a such a global recession fly to the nations out of the U.S. Investors may flee to their home country thereby pulling out of what is currently the haven of quality and choice: America. Should this take place, markets would utterly collapse,, the dollar would drop quite dramatically, resulting in gallopping inflation in a nation that imports vast amounts of foriegn goods.

Obviously the US bubble and boom is soon to die, and such a y2k pullout of markets would be devastating to the U.S. 's economy, and therefore the world economy. The central banks may try to flood the system with money, which is generally known to cause inflatio, but it probably will be ineffective in the long run. This is the great variable: Major inflatio or major deflation? Due to all these factors, as well as strong underlying forces such as the technology boom and the internet, I strongly believe we are to experience tremendous deflation in the years ahead.

Money supply has grown astronomically in the nineties, particularly since 1994. Traditionally this has resulted in price inflation, but not this time, as it has instead gone into and fueled an asset inflation, or bubble in stocks and housing. Other countries; Britain, Sweden and Japan in the eighties have also seen sharp slumps in net savings when they experienced asset-price bubbles in housing or stock markets. Their economies were later severely damaged when bursting asset prices caused savings to rebound to above normal levels, to correct previous over-borrowing. Between 1989 and 1994, for instance, Britain's private net savings rate swung from minus 6% to plus 6% of GDP. The what happened was obvious: a deep recession.

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Home Page:
Year 2000 Economics
by Daniel