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America’s Lost Half Century and the Loss of Values

By    |   Friday, 02 Dec 2011 07:30 AM

Real economic growth in the United States fell precipitously during the last half century.

The reason: A severe values deficit.

During this period, society valued the acquisition of materials in lieu of knowledge and wisdom. The values deficit triggered economic turmoil and the subsequent financial implosion.

Since the 2008 financial crisis, I anticipated anemic economic growth over the next five to 10 years, possibly more, to correct our collective ills.

For decades, debt driven consumption demand, largely in lieu of productive entrepreneurial investment demand, caused the contraction of monetary velocity, the key economic driver.

Monetary velocity (MV) equals the quantity of monetary transactions for a given monetary unit during a specific period of time. More income is generated when a dollar is used multiple times. Therefore, GDP (income) equals MV times MS (money supply).

MV is greater when expenditures are directed toward investment (the beginning of the production cycle) rather than consumption (the end of the production cycle), since more monetary transactions are possible.
During economic expansion, productive investment increases and consumption decreases (both as a percentage of GDP). The opposite occurs during economic contractions (investment decreases and consumption increases).

During the production process, expenditures are made for inputs such as labor and raw materials. More importantly, ancillary expenditures are made by the factors of production, such as labor, using the income they receive. This dynamic flows throughout the production process culminating with consumption at the final point of sale.

From 1994 through 2008, MV for the most liquid monetary aggregate (MZM: Money, Zero Maturity) fell 40 percent, from 2.55 to 1.45. Hence, one dollar of expenditures in 2008 resulted in 40 percent less income than in 1994.

The antithesis occurred since 1959, especially during the three decades from 1980 through 2010.

According to the Bureau for Economic Analysis (BEA), during the previous half century (1959-2009), consumption as a percentage of GDP rose from 45.7 percent to 67.7 percent. This was primarily driven by expenditures for healthcare and financial services, with annual increases of 9.9 percent and 8.7 percent, respectively.

Individual healthcare expenditures fell from 72.7 percent to 17.6 percent as government expenditures rose from 3.4 percent to 45.4 percent, mostly through Medicare and Medicaid. Hence, consumer-centric, market-oriented purchases fell, while bureaucratic expenditures rose. Suboptimal resource allocation occurred, since government has less knowledge of individual needs, less incentive to optimize value, and less accountability for imprudent decision making.

From 1980 to 2008:

1. Consumption as a percentage of GDP rose from 62 percent to 71 percent

2. Savings as a percentage of disposable income fell from 10 percent to 1 percent

3. Total debt as a percentage of income grew more than three-fold to 400 percent.

4. Percentage of total annual income received by the top 1 percent rose from 8 percent to nearly 20 percent.

The rise in debt driven consumerism was precipitated by a massive credit-based monetary expansion.

This occurred coincident with the removal of the more stable gold-backed methodology. The result was a fiat currency with no inherent value, void of capital reserves, based purely on faith and easily manipulated by government policy.

Unlike gold, fiat currencies can be created with a stroke of a computer key.

Gold-based exchange will more readily enable purchase power parity by providing fiat currencies with a stable medium that cannot be readily manipulated individuals, corporations, or government.

Purchase power parity implies the ability to purchase a given commodity in different geographic areas over a period of time with a given quantity of exchange media.

Gold costs roughly $500 per ounce to produce from an established mine and as much as $1,000 per ounce including research, development, and exploration. Each ounce possesses an inherent value that is high durable over time. Almost all of the 165,000 tons of gold that have been mined to date are currently in circulation. In recent years, greater quantities of gold have been recycled for additional uses. This medium of exchange cannot be readily duplicated or manipulated.

More importantly, the production process for gold is a proxy for production in general. As production costs for a specific commodity increases (e.g., clothing), the retail price will tend to rise. This higher production cost will likely be replicated in the cost of gold production as well. Therefore, a similar quantity of gold (at the higher price) will enable one to purchase a given commodity (at the higher price) in different geographical areas over time.

If the price of a given commodity stays constant and the price of gold rises due to other factors than production dynamics, the purchase of that commodity will require a lower quantity of gold.

Excess monetary expansion enabled the camouflage of high risk debt to permeate the market. From 2000 through 2008, financial derivatives increased nearly seven-fold from $100 trillion to $700 trillion.

The causes:

President Bill Clinton’s signing of the Financial Services Modernization Act (1999) and the Commodity Futures Modernization Act (2000).

The 1999 act removed key components of the 1933 Glass-Steagall legislation that separated high risk investment banking from lower risk commercial banking. The 2000 act permitted derivatives to be traded on exchanges and through clearinghouses that were undercapitalized and created excess liabilities (e.g., lack of adequate margin call supervision).

Ultimately, proper debt service was reduced significantly causing a precipitous fall in financial asset prices, especially the hyper-inflated financial derivatives market.

The result: a low velocity debt deleveraging process that may take a decade or more to complete.

Deleveraging is essentially the final consumption purchase, not an investment at the beginning of the production cycle. Therefore, the number of transactions associated with this activity is lower (e.g., lower monetary velocity).

Moreover, real economic growth was inflated in the 1980’s and 1990’s when the Bureau of Labor Statistics (BLS) revised its calculation of inflation. These methodologies reduced the real level of inflation, thereby increasing the real level of growth (real GDP growth rate equals  nominal GDP growth rate minus inflation rate). This was most probably a political calculation by the executive and legislative branches, which was ultimately enabled by the monetary authorities (e.g., the Federal Reserve Board of Governors).

The inflation methodologies that are used to understate inflation include: commodity substitution, hedonic quality adjustments, owner equivalent rent, geometric mean, and “chained dollar” accounting.

Commodity substitution involves substituting less-expensive items for more costly ones in the “consumer commodity basket.” For example, they might replace steak with hamburger.

Hedonic quality adjustments involve reducing the price of an item by removing the additional quality enhancements. This conveniently ignores economic reality. Many of these quality improvements are standard to the product, and the cost of inclusion may be less due to effective economies of scale. For instance, the price of an automobile may be reduced by eliminating the cost of its air conditioner.

Owner equivalent rent eliminates price appreciation due to investment demand. This explains why the inflation figures were rather low from 1994-2006 as real-estate prices exploded. Investment demand needs to be considered. For a property owner to realize a normal return on investment, this additional cost will ultimately be reflected in the supply price for the purchaser of housing (whether for consumption or investment).

The geometric mean provides additional weight to those commodities that increased less in price over the given time frame. Rather than comparing the cost of the entire basket at different times, this measure calculates the price increase of each commodity and multiplies them together. In essence, a fraction multiplied by a fraction generates a smaller fraction. For example, one-half multiplied by one-half equals one-quarter. Therefore, the true price increase of the basket is reduced.

Most recently, in 2005, the Bureau of Labor Statistics (BLS) introduced the application of “chained dollars” to represent the price level. This figure simply measures the rate of increase in expenditures relative to the previous year. This figure does not accurately report inflation for particular products and services.

Due to substitution, individuals may spend less by purchasing a less expensive alternative. Ironically, prices for the commodity basket may rise as spending declines. Using “chained dollar” accounting, this would represent a deflationary environment.

By some estimates, actual inflation may have averaged 1.5 percentage points more than reported each year. This would increase annual real GDP by nearly 1.5 percentage points from 1980 through 2010.

This 30 year distortion may have increased the GDP growth rate by approximately 50 percent. Therefore, actual real GDP may be 33 percent less than reported: close to $9 trillion rather than $13 trillion.
In addition, inadequate education and training over the past 3-4 decades have produced an ill-equipped supply of labor that cannot meet the labor demand.

While the percentage of job openings have increased, unemployment remains high (lower labor participation has kept unemployment relatively constant for the past year).

Total global debt (private and public) is nearly three times greater than global GDP. Strong long term sustainable growth is possible when this ratio is closer to two, representing a 33 percent decline.

Based on historical evidence, global deleveraging of this magnitude may take more than a decade to complete.

For these reasons, I believe global economic growth will be largely anemic over the next 5-10 years, including that for the US.

History will most likely record the previous half century as a major decline in the world’s pre-eminent superpower. Reversing this trajectory will require a decade of responsible and compassionate decision making.

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Real economic growth in the United States fell precipitously during the last half century. The reason: A severe values deficit. During this period, society valued the acquisition of materials in lieu of knowledge and wisdom.The values deficit triggered economic turmoil...
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2011-30-02
Friday, 02 Dec 2011 07:30 AM
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