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Inequality, Inflation, Investment and Instability — The “I”s have it

February 16, 2011

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We begin with epidemiologists Richard Wilkinson and Kate Pickett

[Note, the podcast contains audio from Tom Ashbrook’s On Point interview. The following is an exerpt from the book “The Spirit Level.”]

Inequality: the enemy between us?

As if to overcome their reputation as practitioners of the ‘dismal science’, economists are now producing an economics of happiness. Ironically, what they find is that most of the determinants of happiness are beyond the grasp of the market. Happiness, rather than being determined primarily by income and possessions, is, at least in rich countries, more significantly affected by social relationships – by friendship, marriage, giving and volunteering.

And it’s not just happening in economics. Researchers across a range of academic disciplines are discovering how fundamentally social we are. Neurologists tell us how the pleasure centers in our brains light up when we co-operate with one another, and that feeling socially excluded activates the same areas of the brain as physical pain. Evolutionary psychologists have explained how reciprocal altruism developed. Epidemiologists have discovered that health is strongly protected by friendship and damaged by low social status – findings which are backed up by research on monkeys conducted by primatologists. And psychologists have shown that the kinds of stress which really get under our skin and elevate our stress hormones are those which contain a ‘social-evaluative threat’, such as threats to self-esteem or social status, in which others may judge our performance.


Egypt. Friday, February 11, 2011, a nonviolent mass demonstration removed the head of a corrupt police state. What will follow? Will it be Iran? Something worse? Or will it be Poland? Something better? We led with audio from two British epidemiologists. Not economists, who have done a statistical study across dozens of parameters and found that – however you get there – the more equal your society, the healthier it is in virtually every category. That is not such good news for the U.S., which has fallen into last place among developed economies on measures of income and wealth disparity. But it is great news for Egypt, if they can squeeze themselves into a democratic future. The first Mid-East state which achieves democracy and the rule of law will become the economic and commercial hub of the region. Egypt has that opportunity.

The Financial Crisis Inquiry Commission headed by Phil Angeledes released its report to general criticism, as we’ve already noted. The findings that, one, it could happen again, because (two) nothing is fixed were swallowed up in the current of news. Which causes us finally to abandon our hope for Barack Obama’s presidency. Fundamental change will not happen because the same people are in charge. Wall Street is calling the shots in the Capitol. The clarity of all the campaign rhetoric has stepped in the bog of the continuous campaign. There will be no solution with this regime in charge. Clear systemic and institutional problems need radical action. Not going to happen here. Demand Side blew the political call. We wasted this crisis. Now on to the next one.


A second Fed governor has stepped forward to echo a Demand Side point. A couple of weeks ago we quoted Elizabeth Duke suggesting money is not being created as our textbooks and the procedures manuals of the Fed say it is, implying the authorities we need to look up from their maps and watch the road, because that is not a bridge.

Now, Dennis Lockhart, president of the Atlanta Fed, in a February 8 speech to the Calhoun County Chamber of Commerce agrees that inflation is a general rise in prices, not specific price spikes.

Quoting and abridging that speech to the CCCofC

So what about inflation? … The retail price measures jumped at year end as the price of gasoline rose. But looking beyond the rise in gasoline prices, consumer price increases remained exceptionally modest.

Yet inflation anxiety is rising. There seems to be a disconnect between what the Fed is saying and what people are experiencing when they fill up their gas tanks or read about rising food prices around the world.

… we may be talking about different things. … the term “inflation” is misused in describing rising prices in narrow expenditure categories (for example, food inflation). Nonetheless, recent price news has encroached on the public consciousness with the effect that any price rise of an important consumption item is often taken as signaling inflation.

Inflation affects all prices. Inflation is not the rise of individual prices or the rise of categories of prices.

The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere —events that cause prices of certain goods to rise and change your cost of living.

DS: Well, maybe. The Fed is certainly proving its powerlessness, since it is trying like hell to increase house prices by forcing down interest rates. The principle objects of this exercise, we think, is to support the value of loans it took onto its own balance sheet and to keep those still held by the banks from blowing holes in their balance sheets. On the other hand, stock markets, emerging economies and commodity futures have all seen price rises that must be laid at the door of the Fed.

Question: IF inflation were going to happen, why wouldn’t you financial geniuses lock in zero interest?

Bonus question: IF restrictive monetary and fiscal policy cuts inflation and spurs growth, explain the U.K.

Former U.S. Treasury Department undersecretary John Taylor has called for overhauling the Federal Reserve’s dual mandate of ensuring stable prices and maximum employment, saying that the central bank should focus on prices.

“It would be better for economic growth and job creation if the Fed focused on the goal of “long run price stability within a clear framework of economic stability,’” Taylor told the House Financial Services Committee. …

Taylor said that “too many goals blur responsibility and accountability.” …

Two is too many, says Taylor. Never mind that one is also too many when the Fed has no clue. Or that the Great Moderation of price stability that the Fed congratulated itself for ad nauseum was the curtain hiding a great explosion of debt. Well, housing is not counted when they count prices.

To the credit of Ben Bernanke and others at the Fed, they are resisting the inflation hawks who – only marginally muted by years of below target inflation — are seizing on the latest commodity bubble as proof of their hysterical imaginings. Bernanke is focusing on core inflation. Core inflation excludes energy and food, hence many commodities. So far, so good. But what does that leave for core inflation to include? Labor. So we see core inflation stagnating and, yes, labor income is stagnating.

But what will happen if core inflation ticks up, as it must do when investment returns? Bernanke will no doubt put the screws to the economy. At least that is the Demand Side prediction. We note that we predicted this the last time, too, in early 2008. But the economic collapse occurred prior to core inflation ticking up. The same thing might happen again.


Nowhere is the absence of real change in the Wall Street Culture more evident than in Goldman Sach’s $2 billion deal for Facebook, announced last month, which valued the social networking site at $50 billion.
As Martin Hutchinson from Prudent Bear said at the time, this

combines the worst elements of the 1997-2000 and 2004-07 bubbles. It sets a grossly excessive valuation on an Internet company with modest revenues and prospects. It also involves an investment bank structuring a complex deal to maximize its own fees, while driving a truck through two major elements of financial services regulation. Add a third element, that it places a company controlling personal information on 500 million users in close business partnership with a Russian billionaire with a criminal record and you can see the deal is truly groundbreaking. It should also raise important red flags about current market conditions.

Cheap money always does this; it feeds the worst instincts of the Wall Street crowd. When prolonged for almost 16 years, as currently, it cements the Wall Street speculative worldview into revealed truth, against which no contradiction can stand. The opposing approach, of sound investment only in projects that make economic sense, appears quaint and outdated, like Republicanism in the late 1940s or Marxism in the 1990s. After all, in a period in which leverage and speculation have proved generally profitable for 16 years, who’s to say that they may not indeed be the appropriate way to finance economic expansion? A bubble that lasts for almost two decades becomes increasingly difficult to distinguish from reality, because skeptics have been marginalized and battered for so long.

Like all bubbles, this one will end. What’s more, it will end fairly quickly because there is a limited remaining supply of rocket fuel to give it impetus. Commodity prices have now risen to levels mostly above the peak of the 2008 boom, and in doing so have fueled inflationary and contractionary forces that will destabilize the U.S. economy within a matter of months. No doubt Wall Street, the Fed and the politicians will use every artifice to prolong the mania, but it may not be prolongable. Nobody wanted the housing bubble to burst in 2007, or Lehman Brothers to fail in 2008, but market forces eventually proved too powerful for the optimists. Similarly in this case, the market will prove too strong for those attempting to keep the bubble inflated. By the end of this year, the bubble’s contradictions will already be fully apparent, although judging by past experience it may be late 2012 before catastrophe finally hits.

One can only hope that, unlike in 2008, the response of the political class will not be to try and re-re-inflate the bubble by any means possible. It is long past time for sound monetary policy, for sound fiscal management and for investment driven by solid value rather than by speculative excess.

Martin Hutchinson

Who goes on to recommend a regime where liquidity is eye-wateringly expensive. Such a regime would wring the excesses out of the system. Demand Side says it is too late for that. The excesses are so large and dangerous that they have to be cut out. Public goods, equality, debt reduction, healthy Main Streets are the only hope.
Also at Prudent Bear. Doug Noland joins Demand Side in remarking on similarities between this year and the GFC year 2008. Noland focusing on financial markets. Quoting,

The first few weeks of 2011 have me recalling early-2008. It’s as if someone reached over, flicked a switch and changed market dynamics. Abruptly, last year’s outperformers have come under heavy selling pressure, while the underperformers have in many cases caught strong bids. Things are unsettled and there are divergences. And I’m not just talking U.S. equities.

The dollar index jumped 2.5% the first week of the year, sank 2.3% the second week and declined a further 1.3% this past week. Reminiscent of currency market volatility back in January 2008, the euro has gained 1.8% y-t-d against the dollar, this despite a 3.5% decline the first week of the year. …
Players began 2008 out of synch, with trading conditions across various asset classes turning challenging – and progressively frustrating. Almost overnight, uncertainty seemed to take root throughout equities, fixed-income, currency and commodities markets. Breathtaking moves and abrupt market reversals began to subtly take their toll. Things that had worked quit working. An increasingly uncomfortable crowd of speculators saw their various long exposures lag and their shorts outperform.

And it wasn’t all that long before losses began to mount and defensiveness became the order of the day – with inflated markets hanging in the balance. De-risking and de-leveraging then fueled atypically high correlations amongst various markets, causing considerable angst for the leveraged players and others dependent upon “quant” models. The “wrecking ball” of high volatility and highly-synchronized global risk markets began working against systemic stability. This dynamic fed – and was being fed by – the concurrent rapid slowing of mortgage Credit. Instability took on a life of its own, as markets dependent upon abundant liquidity and speculation began to suffer withdrawals.

There have been various recent reports suggesting that hedge fund assets and leverage have returned to near pre-crisis levels. Record industry assets seem reasonable to me; near record leverage does not. A major increase in speculative leverage is not apparent from ongoing stagnation in Wall Street balance sheets, bank Credit, and reported “repo” positions. There is, at the same time, the huge unknown of “carry trade” leverage embedded throughout global currency and fixed-income markets. And while I doubt the leveraged players are today the marginal source of marketplace liquidity to the extent they were in 2008, they are surely a major force to be reckoned with.

With parallels to 2008, the success or failure of the leveraged players takes on additional prominence now that there are cracks in the global government finance Bubble. On the margin, global yields continue to have an upward bias.

I have argued [says Noland] that the Fed’s “activist” policymaking from the second-half of 2007 actually exacerbated systemic fragilities and contributed directly to the severity of the 2008 crisis. The overabundance of liquidity, coupled with the perception that policymaking would restrain the unfolding debt crisis, proved destabilizing and, inevitably, devastating. They fostered intense speculative excess, inflated market prices, unsustainable financial flows, and Bubble Dynamics. Myriad booms were fun while they lasted, although the heavy costs included heightened uncertainty and fragilities. Last year’s discussion and then implementation of “QE2” has had similar effects.

Marketplace liquidity can be steadfast or fickle. Market confidence varies between incredibly resilient to stunningly fleeting. To be sure, crises of confidence are difficult to predict. But one can monitor and gauge the forces that create susceptibility to abrupt shifts in market sentiment and altered trading conditions. Policymaker responses to structural problems (i.e. zero rates, massive monetization, federal stimulus and “Build America Bonds”) created distortions in risk perceptions and the flow of finance to the muni sector, while in the process delaying needed structural reform. The muni debt issue was allowed to fester; financial market distortions worsened.

For now, QE2 reliably generates additional liquidity for the liquidity-dependant markets. Somewhat ironically – yet altogether Bubble-like – rising bond yields and unfolding problems in municipal finance have bolstered flows into equities. And on the back of ongoing federal spending excess, economic prospects look ok and earnings appear swell. Yet recent developments do beckon for heightened diligence when it comes to monitoring for fissures developing below the surface of our fragile financial system. At least from my perspective, one can now discern unsettling parallels to early 2008

That’s Doug Noland, Prudent Bear, all links online.

Now for a few minutes more of British authors and epidemiologists Richard Wilkinson and Kate Pickett. This is lifted from an On Point interview by Tom Ashbrook. You have heard us here at Demand Side arguing the economic inefficiency of inequality, but these people are describing the social effects of inequality.

[Podcast audio continues with the Ashbrook interview.  Below for blog readers is a continuation of the exerpt from the book.]

Where it once took studies of babies’ weight gain to discover that they needed attentive and loving care, it is now studies of death rates which are forcing us to recognize the social needs of adults. What matters most now for health, happiness and well-being is, from early childhood onwards, social relationships, the quality of the social environment, and how we experience ourselves through each others’ eyes.

For thousands of years the best way of improving the quality of human life was to raise material living standards. But we, in the rich world, are the first generation to have got to the end of that process . The evidence on life expectancy, happiness and measures of wellbeing show that there are rapid improvements in the early stages of economic growth, but the gains then diminish until, among the richest countries, all three cease to be responsive to economic growth. The ‘diseases of affluence’ – like heart disease – become the diseases of the poor in affluent societies and, for the first time in history, the poor are fatter than the rich.

At some point in the long history of growth it was inevitable that we would reach a point where diminishing returns set in. That we have passed this point has been masked by consumerism. But what drives consumerism – and makes it an insatiable but zero-sum game – is that rather than being driven by genuine human need, it is driven by status competition, by the need to have goods that show other people how well we’re doing and to keep up with the Joneses. When a large majority, even of the 10 or 15 percent of Americans below the Federal poverty line, have air conditioning, a car and a DVD player, growth has done its work.

In their bones people know this. We know that consumerism is hollow and cannot satisfy our deeper and more important social needs. Similarly, the romantic nostalgia for the 1950s reflects our recognition that, despite our societies being so much richer, people are no happier now than they used to be.

No wonder then that Gross National Income per head has been falling out of favor as a measure of progress in rich countries. Almost twenty years ago the United Nations introduced its Human Development Index and scored each country according to a combined measure of Gross Domestic Product per head, education and life expectancy. Since then, economists have developed many other measures of wellbeing, the ‘Genuine Progress Indicator’, the Happy Planet Index and the like. Most recently, Nobel laureates Joseph Stiglitz and Amartya Sen produced their report on measures of economic performance and “social progress” for France’s President Sarkozy.

But if you thought the Stiglitz-Sen report would tell us how to increase human wellbeing, you’d be disappointed. Rather than showing us how to improve wellbeing, they focus only on how to measure it. Even within this limited scope, the suggested improvements are remarkably pedestrian. Despite the sharp contrast between the material success and social failings of modern societies, they keep Gross National Income per head at center stage. The changes they propose are limited to various subtractions from GNI per head to take account of costs which boost economic growth such as longer commuting times, pollution and loss of leisure, while making additional adjustments, such as for the fact that we do not share the proceeds of growth equally. But this report is nevertheless important because it confirms the growing awareness that we have got to the end of the real benefits of growth.

So if the priority really has shifted from our material to social needs, what can be done in affluent societies to raise the real quality of life? Rather to our surprise, we believe we have found a crucially important part of the answer to this question.

Like others, we had been working for some years trying to understand the tendency for health to be better in countries with smaller income differences between rich and poor. There are now around 200 studies of income inequality and health. Other researchers working on violent crime had shown that homicide rates were lower in more equal countries. We started to wonder whether this pattern applied to other health or social problems. To find out, we collected internationally comparable figures on levels of trust, mental illness, life expectancy, infant mortality, prevalence of drug use and levels of obesity, homicide rates and rates of imprisonment, teenage birth rates, children’s educational achievement, and measures of child wellbeing – for each of 21 rich developed market democracies.

To measure inequality we used the ratio of the incomes of the top 20 percent in each country compared to the incomes of the bottom 20 percent. In the more equal countries (Japan, Finland, Norway, Sweden) the top 20 percent have 3.4 to 4.0 times as much. In the more unequal societies (USA, Portugal, UK) they have between 7 and 8.5 times as much. By this measure they are twice as unequal as the more equal countries.

Although people have often regarded inequality as divisive and socially corrosive, that did not prepare us for what we found. The frequency of all these problems was systematically related to income inequality. The bigger the income differences between rich and poor in each society, the worse these health and social problems became. And rather than things being just a bit worse in more unequal countries, they were very much worse. More unequal countries tended to have three times the level of violence, of infant mortality and mental illness; teenage birth rates were six times as high, and rates of imprisonment increased eight-fold.

The sense that inequality is divisive was shown by the fact that in more unequal countries, only about 15 percent of the population feel they can trust others, compared to around two-thirds in the more equal ones. That evidence was supported by relationships with social capital and levels of violence – all showing that inequality damages the social fabric of society.
Although the statistics told us that these relationships could not be dismissed as chance, we thought we should check in a second, independent, test bed to see if the same relationships held true. We looked at data for the 50 states of the USA, asking exactly the same question: did the more equal states, like the more equal countries, also do better on all these health and social problems than the less equal ones?

The pattern was extraordinarily similar. What the evidence shows is a tendency for more unequal societies to be socially dysfunctional right across the board. It is not that one country or state has good health but high levels of violence, or high teenage birth rates but low levels of drug abuse. Instead, the pattern is for most problems to become better or worse together.

Our interpretation of these findings is that bigger income differences lead to bigger social distances up and down the status hierarchy, increasing feelings of superiority and inferiority and adding to status competition and insecurity. Some of the causal links are known: the effects of chronic stress on the immune and cardiovascular system are increasingly well understood and must underpin the relationship of income inequality to health. Similarly, the reason why violence increases in more unequal societies is because inequality makes status even more important and the most common triggers to violence are loss of face, disrespect, and humiliation.

What the evidence shows is that problems that everyone knows are related to social status within our societies become much more common when the social status differences are increased. But, surprisingly, the benefits of greater equality are not confined to the poor. While the benefits are much bigger lower down the social ladder, even well paid middle class people live longer and do better in more equal societies. Their children too are less likely to become victims of violence, to drop out of high school or become involved in drugs. The reasons why the benefits of greater equality extend to a large majority of society is, of course, that we are all caught up in status differentiation and we all worry about what others think of us and how we are judged.

How can income differences be reduced? There seem to be two quite different routes. While countries like Sweden start off with large differences in earnings and then redistribute, countries like Japan have much smaller earnings differences to start with – before taxes and benefits. Within the US, Vermont and New Hampshire provide a similar contrast. It doesn’t seem to matter how you get greater equality so long as you get there somehow.

Politics in the future are likely to be dominated by the need to reduce carbon emissions. But there too greater equality has a role to play. Consumerism is probably the greatest obstacle to achieving sustainability. Because the pressure to consume is intensified by status competition, greater equality will be necessary to reduce it. Reigning in carbon emissions depends, more than any other problem, on concern for the greater good. But as inequality weakens trust and community life, it also weakens public spiritedness and concern for the greater good. An international survey of business leaders found that those in more equal countries regard environmental issues as more important. It is also the more equal societies that do best on recycling and foreign aid.

Both our social and environmental wellbeing require that developed societies turn their attention from material accumulation to the quality of the social environment. What is exciting is that greater equality may be the key which brings solutions to the most important problems of our day within our reach.


From → Income, Inflation

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