Predicting Recessions The Easy Way: Monetarists, MMT, And The Money Stock

August 25th, 2015 Comments off

I have a new post up that has implications for stock-market investment, so I decided to try posting it over at Seeking Alpha, where they’re paying me a few tens of dollars for the post (plus more based on page views — not much luck so far).

The post argues that year-over-year change in Real Household Net Worth has been a great predictor of NBER-designated recessions over the last half century. (It’s either 7 for 7, or 8 for 7, over 50+ years, depending on the threshold you use.) If you were following this measure, you would have gotten out of the market on March 6, 2008, avoiding a 50% drawdown over the next twelve months.

But the post goes farther, offering a somewhat monetarist economic explanation but using total household net worth as the measure of the “money stock.” Short story: if households have less (more) money, they spend less (more). Not exactly a radical behavioral economic assertion.

If you’re wondering how recent days’ market events have caused billions (trillions?) of dollars to “disappear,” and are pondering how to think about that, you might find it an interesting read.

Cross-posted at Angry Bear.

Which Countries Work Hardest? You Might (Not) Be Surprised

June 30th, 2015 Comments off

Imagine you had to choose, and could choose: you can spend your whole life and raise your family in either of two equally prosperous countries. In one country people work lots of hours to attain that prosperity. In the other country people work far less. You don’t know anything else about these countries.

Which would you choose? The answer seems kind of obvious, right? Equally prosperous, and less work for me and my family? Sign me up!

But that straightforward question is almost never asked, explicitly, in discussions of prosperity, growth, and national well-being. The most obvious measure of that difference — hours worked per capita — is buried, invisible, and unavailable in the various national data sets scattered around the web. (The typical national measure you see out there is hours worked per worker.)

For the curious, here’s how more-prosperous countries (OECD and a handful of others) sort on the “hard-working” scale:

Screen shot 2015-06-28 at 5.35.57 PM

This average includes the whole population — workers, children, students, retirees, etc. — so it’s an index of how much the average person has to work over the course of their life. (More hours during working years, less or none during non-working years; it’s an average.) 

There’s one main generalized takeaway from this that I see: The less-work end of the spectrum is dominated by western European countries. People there work far less hours in the course of their lives. People in “Anglo”-model countries work far more.

Going back to choosing a country: you also want to know how prosperous it is in pure money terms, using something like GDP per capita. Here’s that (I’ve excluded tiny, crazy-high-GDP Luxembourg here — think: banking — to show other countries more clearly):

Screen shot 2015-06-30 at 12.08.53 PM

If you’re a rational shopper, you’ll choose Norway (yeah, they’ve got the advantage of all that oil…), Ireland, the Netherlands, or another country in the upper left. If an extra $5,000 or $10,000 a year is worth sacrificing four or five extra weeks of work, choose the U.S. (Think: “buying” an extra month of time with your family, doing things you like and love, every year. You decide. But do I need to remind you that 1. Life is short, and 2. “Family values” really do have value?)

One perhaps-surprising takeaway from this graph: hard-working countries aren’t richer. QTC. Causation? It seems improbable that working less would cause higher prosperity. Higher prosperity could quite reasonably cause people to work less. (The good old substitution effect, income versus leisure.) But the most likely conclusion is that high productivity (GDP per hour worked) is the 800-pound gorilla when it comes to prosperity. Long hours worked have zero or negative apparent effect on prosperity.

(Interesting parallel: hours worked per household member in the U.S. only “explain” seven percent of the variance between household incomes. Whodathunkit?)

Rather than eyeballing that scatter plot, you might want a handy index of which country to choose. Here’s one approach to what I’ll call Work-Weighted Prosperity: GDP/Capita divided by Hours Worked/Capita. If people in one country have to work lots of hours to get that prosperity, it gets ranked lower.

Screen shot 2015-06-29 at 6.06.17 AM

The takeaway here? Move to Luxembourg and get into banking.

The curious among you are probably wondering about different countries’ working-age populations (doesn’t actually vary that much), and the percentage of working age that are working (varies somewhat more). Here’s the spreadsheet.

Cross-posted at Angry Bear.

Scalia’s Craven Self-Contradiction and Pettifogging Pedantry

June 26th, 2015 Comments off

In his dissent to Edwards v. Aguillard, Supreme Court justice Antonin Scalia made a neat distinction, sidestepping the issue of “legislative intent” that he finds so troubling:

it is possible to discern the objective “purpose” of a statute (i. e., the public good at which its provisions appear to be directed),

(The dissent is obsessed with “purpose”; the word appears 76 times therein.)

But in his dissent on yesterday’s King v. Burwell (Obamacare) decision, he chooses to ignore that statute’s obvious, objective purpose: to provide subsidies for buyers of exchange plans.

Rather than doing as he proposes, trying to “discern the objective ‘purpose’ of a statute'”, he seeks to deny the statute’s obvious purpose by determining the “purpose” of a few words therein — with a statement that can only be perceived as intentionally obtuse:

it is hard to come up with a reason to include the words “by the State” other than the purpose of limiting credits to state Exchanges

This very smart man could easily “come up with a reason.” Since those words contradict the obvious, objective purpose displayed by everything else in the statute, the words were accidentally misphrased. You might even go so far as to say that this is the obvious, “objective” conclusion.

Scalia would agree. In his dissent on the previous Obamacare challenge, he says:

“Without the federal subsidies . . . the exchanges would not operate as Congress intended.”

You may feel free to quibble over “purpose” versus “intention,” but the obvious, objective, intentional purpose of the statue was to give subsidies to purchasers of exchange plans.

Any attempt to deny or obscure that reality is pettifogging pedantry. Nothing more.

Update: Bruce Webb in comments shows just how objectively obvious the “purpose” is. The title of the statute’s opening section (emphasis mine):

Title I. Quality, Affordable Health Care for All Americans

Cross-posted at Angry Bear.

No: Rich People Don’t Work More

May 11th, 2015 Comments off

The meme is ubiquitous, and widely documented: Rich people work longer hours. Obvious implication: they deserve what they get, right? Ditto the poor.


Why? All the research supporting that meme looks at workers, not families. It completely ignores students, the retired, and anyone else who isn’t working. Alert the media: workers work and earn more than non-workers.

And, news flash: rich families are full of non-workers. If you look at families and their hours worked per person, you see a very different picture:

image (2)

Here’s the same 3+ household data for working-age families only: those with a head of household under age 65.

Screen shot 2015-05-11 at 9.48.05 AM

Pretty much the same story.

This is all based on a fast-and-dirty random census pull of about 5,000 U. S. households, from IPUMS. It uses 3+ households as a proxy for families — probably not a bad proxy. A professional economist doing proper due diligence would fine-tune that, or even better turn to the Panel Study of Income Dynamics (PSID), which has better microdata to track families. Careful work would even allow them to track extended, multi-generation families, not just nuclear families living together. (Think: dynasties.) I’d expect the pattern we see here to be more pronounced in that view (though that’s just a surmise).

Here’s some more evidence, from across the pond:

Figure 1: Average hours of work across the distribution of earnings: UK, 2013


Figure 2: Changes in post-tax real hourly earnings and average hours for the median and top 1 per cent


Even as rich people’s incentives to work have skyrocketed, their hours worked have plummeted. This even though they’re far more likely to be doing interesting, engaging work in pleasant environments. Curious.

But still: low-income people work less. More of them are unemployed. Is that a surprise to anyone? (I’ll leave the “voluntary” argument to my gentle readers.)

There’s a stylized fact out there, universally repeated by economists and pundits, that seems to misrepresent the state of the world. There are some nice tractable research projects here for those who are paid to do such things.

Cross-posted at Angry Bear.

American Exceptionalism Re-Revisited: OECD Taxes/GDP Since 1965

April 26th, 2015 Comments off

Darwin Wept: Pyramid Schemes, Collusion, and Price-Fixing, the Modern American Way

April 21st, 2015 1 comment

The story hardly bears repeating:

Pricing is the ultimate miracle of Darwinian markets. Competitors who produce goods at lower prices thrive, expand their operations, and produce more. Those who charge higher prices (for equivalent goods) are driven to extinction when sensible purchasers abandon them for their more-efficient competitors. This inexorable mechanism drives innovation, investment, and productivity, and the eternal grinding evolutionary churn of “creative destruction.” Survival of the fittest makes us collectively fitter, and fills our wants and needs at ever-lower prices.

All of that, or course, requires price competition among producers. The ultimate bogeyman, choking that mechanism, is competitors colluding to fix their prices. If they agree not to compete with lower prices — collectively stealing higher profits from their customers — the pricing mechanism doesn’t exist, and its manifest benefits are denied us.

It’s a compelling and convincing story. But: The key word in that second paragraph is “agree.” It’s illegal, of course, for competing firms to explicitly collude to set higher prices. But price collusion occurs constantly at higher, institutional levels, where it is unstated, implicit…and profoundly pernicious.

The Economist highlights this reality in its recent package on family companies. We’re not talking mom-and-pop shops: this is about vast networks of corporations controlled and owned by small groups of families — especially common in Asia (South Korea!), but also in Europe. The small control groups at the top of these pyramids have every incentive to back off on price competition among their subsidiaries, reaping higher profits at the expense of their customers. And they have the wherewithal to do it:

Randall Morck, the academic, finds that in large parts of the world pyramidal business groups allow “mere handfuls of wealthy families” to control entire economies.

A stylized diagram depicts the rather obvious mechanism for this control and collusion:

With all competitors controlled, ultimately, by a handful of actors, price collusion seems inevitable.

Interestingly, The Economist continues:

This problem is particularly marked in developing countries, but is also common in much of the rich world, except in the Anglo-Saxon sphere.

In America, we do things differently. In a recent Slate article,  and  explain our innovative, fiendishly clever, and truly “exceptional” mechanism for pyramid control:

Mutual Funds’ Dark Side: Why airlines and other industries keep prices too high

They cite a paper by José Azar showing that:

United’s top five shareholders—all institutional investors—own 49.5 percent of the firm. Most of United’s largest shareholders also are the largest shareholders of Southwest, Delta, and other airlines. The authors show that airline prices are 3 percent to 11 percent higher than they would be if common ownership did not exist. That is money that goes from the pockets of consumers to the pockets of investors.

We’ve all watched this airline-pricing scenario play out over recent months, with fuel costs plummeting while airfares remain unchanged.


The investment management company BlackRock is the top shareholder of the three largest banks in the United States; BlackRock is also the largest shareholder of Apple and Microsoft. The companies that are the top five shareholders of CVS are also the top five shareholders of Walgreens. (And yes, one of them is BlackRock.) Institutional investors dominate the economy.

If you’re like me, you’re immediately wondering: Really, how does the price-fixing actually happen? The answer isn’t terribly surprising, or far to find (emphasis mine):

How exactly might this work? It may be that managers of institutional investors put pressure on the managers of the companies that they own, demanding that they don’t try to undercut the prices of their competitors. If a mutual fund owns shares of United and Delta, and United and Delta are the only competitors on certain routes, then the mutual fund benefits if United and Delta refrain from price competition. The managers of United and Delta have no reason to resist such demands, as they, too, as shareholders of their own companies, benefit from the higher profits from price-squeezed passengers. Indeed, it is possible that managers of corporations don’t need to be told explicitly to overcharge passengers because they already know that it’s in their bosses’ interest, and hence their own. Institutional investors can also get the outcomes they want by structuring the compensation of managers in subtle ways. For example, they can reward managers based on the stock price of their own firms—rather than benchmarking pay against how well they perform compared with industry rivals—which discourages managers from competing with the rivals.

(This is right out of Chomsky’s Manufacturing Consent: media corporations control news content by hiring people who they know will deliver the content, and message, they want. Those who do so are promoted and rewarded. They don’t need to tell them explicitly what to write.)

In America, you don’t find the explicit, extreme, and obvious family-pyramid control that’s so apparent in some other parts of the world. Control and ownership is more widely distributed across perhaps a hundred or a thousand families at the top. (Before you object: it depends on how you define “family” and “the top.”) How could price collusion happen among this larger group, with the inevitable incentives for some to defect with lower prices and take market share from the others?

Simple: America’s richest families have farmed out their collusion to institutional entities who control markets (and market pricing), with small groups of institutions controlling all the players in each industry.

The Darwinian view that underpins the “free market” belief system reveals a fundamental misunderstanding of a key evolutionary mechanism: groups can thrive and propagate at the expense of other groups, if members of one group are better cooperators. That cooperation can take myriad forms (both beneficial and pernicious to the common weal), and there are myriad evolutionary mechanisms by which that cooperation can arise. However it arises, in the case of price-setting within groups, we call that cooperation “collusion.”

In Posner and Weyl’s telling locution, “Competition among mutual funds cannot substitute for competition among corporations.” Ditto if you replace “mutual funds” with “private equity firms.” And likewise: competition among limited-liability corporations (Can’t pay off that loan? The people walk away scot-free) is based on incentive structures that are utterly orthogonal to those of independent butchers and bakers.

The agents operating those institutions know quite clearly which side their personal bread is buttered on. The families who ultimately own everything, meanwhile, are many stages removed from, largely unconscious of, any particular pricing decisions. But they can be confident that those decisions are being made in their families’ best interests.

Adam Smith, poster-boy for free-market enthusiasts, understood this reality better than most:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

He could not perhaps have conceived, however, how cleverly colluders would construct institutions that would achieve that price collusion, while masking and obscuring it even from their own eyes. He perceived the familiar “principal-agent” problem of joint-stock companies quite clearly:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

But he didn’t perceive these institutions’ potential for price collusion.

America’s founders, on the other hand, displayed and expressed a far deeper distrust of limited-liability, joint-stock companies. Charters for such companies were uncommon and extremely restricted in their scope (building a particular public work, for instance) well into the 19th century. “Any legitimate business purpose” is a very recent innovation.

But there’s another crucial innovation: corporations owning shares in other corporations (the very crux of modern pyramid-control schemes, familial and institutional). This was not even legal under state corporate charters until late in the 1800s. The ill effects of that rule change were not long in coming, and had to be addressed vigorously via the trust-busting and rule changes of the early 1900s. (See: interlocking directorships and The Pujo Committee.)

Proponents of free markets seem unaware that that “peculiar institution” — corporations owning corporations — is in fact very peculiar indeed. It is arguably the most destructive innovation ever to strike at the miraculous wonder of the free market’s pricing mechanism.

Further Reading

Anti-Competitive Effects of Common Ownership. April 15, 2015. José Azar, Martin C. Schmalz, and Isabel Tecu.

Concentrated Corporate Ownership. 2000. Randall K. Morck, ed.

Competitive Effects of Partial Ownership: Financial Interest and Corporate Control. 2000. Daniel P. O’Brien and Steven C. Salop.

Do Publicly Traded Corporations Act in the Public Interest? March 1990. Roger H. Gordon.

Financial transaction costs and industrial performance. April, 1984. Julio J. Rotemberg.


Cross-posted at Angry Bear.

National Debt: Since When is the Fed “The Public”?

April 14th, 2015 12 comments

This issue has been driving me crazy for a while, and I never see it written about.

When responsible people talk about the national debt, they point to Debt Held by the Public: what the federal government owes to non-government entities — households, firms, and foreign entities. (Irresponsible people talk about Gross Public Debt — an utterly arbitrary and much larger measure that includes debt the government owes to itself.)

Debt Held by the Public is the almost-universally-accepted measure of “the national debt.” That would be perfectly reasonable, except that…

Federal Reserve banks are counted as part of “the public.” So government bonds held by this government entity — money that the government owes to itself — are counted as part of the debt government owes to others.

The Fed has bought up trillions of dollars in government bonds since 2008, to the point that Debt Held by the Public has become an almost meaningless measure (click for source):

fredgraph (15)

Here it is as a percent of GDP:

fredgraph (16)

Debt actually held by “the public” equals 57% of GDP — and declining — not 73% of GDP.

I don’t know how economists or pundits think they can have any conversation at all about this subject, analyze it in any useful way, if they ignore this basic reality. Reinhart and Rogoff, are you listening?

Cross-posted at Angry Bear.

Why Liberals Keep Losing

March 4th, 2015 2 comments

James Carville was certainly right: “It’s the economy, stupid.”

And under Democrats (compared to Republicans), the economy kicks ass:

Screen shot 2015-02-23 at 8.41.56 AM

This is GDP growth, but that kick-assness is blatant in any economic measure you look at, from job growth to stock-market returns to household income to government deficits. And it’s true over any lengthy period (say, 30+ years) over the last century. I could post fifty graphics here that tell exactly the same story. (Here’s a favorite: even the rich get richer under Democrats.)

But now ask yourself: how many Americans know that Democrats make them richer? (Lots richer.) One in ten? Maybe? Now ask yourself why liberals keep losing.

The Republicans have successfully branded themselves as “the party of growth,” and Democrats have just let them do it, for decades — even though it’s completely contrary to reality.

Democrats have the strongest possible political argument sitting in their rhetorical holsters, but for whatever reasons, they just won’t draw.

There is one and only one story that Democrats need to be telling, and they need to follow the Republican political playbook: repeat it endlessly, for years on end:

We will make you richer. We’ve been doing it for decades, and we’ll keep doing it.

“Equality” is important (especially because it does make people richer). But really: Americans just change the channel.

“Opportunity” is important. But it’s just a proxy for, a chance of, getting richer.

“Getting the rich” (truly progressive taxes, a more-level playing field, reining in finance) is necessary and important. But Americans get only visceral satisfaction from that message — it doesn’t speak to personal, direct, material benefit that they’re going to experience.

Americans want to hear how Democrats are going to make them more prosperous. Full stop.

And Democrats have a loud-and-clear story on that subject. They just need to 1) tell that story constantly, repetitively, ad nauseum, like the Republicans do, and 2) put aside other stories (like, identity politics) that dilute, confuse, and distract from that story.

Start with that lede — “we make America prosperous” — and a whole litany of talking points emerges. And they’re the very talking points that have driven Republicans’ (otherwise inexplicable) political success over the last thirty years.

But there’s one key advantage for Democrats: In their mouths…the story is true.

Democrats could be stealing Republicans’ best Frank Luntz/Grover Norquist talking points and riding them all the way to the ballot box. Here’s a sampling to start with:

Wisdom of the Crowds. Democrats’ widespread government spending — education, health care, infrastructure, social support — puts money (hence power) in the hands of individuals, instead of delivering concentrated streams to big entities like defense and business. Those individuals’ free choices on where to spend the money allocate resources where they’re needed — to truly productive industries that deliver goods people actually want.

Preventing Government “Capture.” Money that goes to millions of individuals is much less subject to “capture” by powerful players, so it is much less likely to be used to then “capture” government via political donations, sweetheart deals, and crony capitalism.

Labor Market Flexibility. When people feel confident that they and their families won’t end up on the streets — they know that their children will have health care, a good education, and a decent safety net if the worst happens — they feel free to move to a different job that better fits their talents — better allocating labor resources. “Labor market flexibility” often suggests the freedom (of employers) to hire and fire, but the freedom of hundreds of millions of employees is far more profound, economically.

Freedom to Innovate. Individuals who are standing on that social springboard that Democratic policies provide — who have that platform beneath them — can do more than just shift jobs. They have the freedom to strike out on their own and develop innovative, entrepreneurial ventures that drive long-term growth and prosperity (and personal freedom and satisfaction) — without worrying that their children will suffer if the risk goes wrong.

Give ten, twenty, or thirty million more Americans a place to stand, and they’ll move the world.

Profitable Investments in Long-Term Growth. From education to infrastructure to scientific research, Democratic priorities deliver money to projects that the free market doesn’t support on its own, and that have been demonstrated to pay off many times over in widespread public prosperity.

Power to the Producers. The dispersal of income and wealth under Democratic policies provides the widespread demand (read: sales) that producers need to succeed, to expand, and to take risks on innovative new endeavors. Rather than assuming that government knows best and giving money directly to businesses, Democratic policies trust the markets to direct that money to the most productive producers.

Fiscal Prudence. True conservatives pay their bills. From the 35 years of declining debt after World War II (until…Reagan) to the years of budget surpluses and declining debt under Bill Clinton, Democratic policies demonstrate which party deserves the name “fiscal conservatives.”

Labor and Trade Efficiencies. The social support programs that Democrats champion — if they truly provide an adequate level of support — give policy makers much more freedom to put in place what are otherwise draconian, but efficient, trade and labor policies. If everyone is guaranteed a decent wage by an excellent program like the Earned Income Tax Credit, we have less need for the admittedly mixed blessings of unions and protectionism.

Take the graph from the top of this post and put it on billboards all over America. It’s time for Americans to understand who makes them richer.

Cross-posted at Angry Bear.

Is GDP Wildly Underestimating GDP?

January 23rd, 2015 31 comments

The markets have been showing a rather particular schizophrenia over the last dozen or so years — but not, perhaps, the one you may be thinking of. This schizo-disconnect is between the goods markets and the asset markets, and their valuations of U.S. production.

In short, the existing-asset markets think we’re producing and saving far more than we see being sold and accumulated in the newly-produced-goods markets. Take a look:

Screen shot 2015-01-23 at 6.17.38 AM

(See here for some ways to think about these measures. The spreadsheet cumulating saving is here. You can find all the data series on Fred here.)

A huge gap has emerged between what we’ve saved and what we’re worth.

Household Net Worth is the asset markets’ best estimate of what all our privately-held real assets are worth. It’s our best or perhaps only proxy for that value. (Household net worth includes all firms’ net worth, since households are firms’ ultimate shareholders. Firms, by contrast, don’t own households. Yet.) This is not just about assets like drill presses and buildings, but also skills, techniques, knowledge, organizational systems, etc. — all the tangible and intangible stuff that allows us to produce more stuff in the future. Household Net Worth at least provides us with an index of the change in that total value, as estimated by the asset markets.

As we increase our stock of real assets (“save,” by producing more than we consume), household net worth (wealth, or claims on those real assets) increases. The valuation jumps up and down as asset markets re-evaluate what all those real assets are worth — how much output and income they’ll produce in the future — but the two measures generally (should) move together.

Except: Since about ’98, and especially since ’02, that hasn’t been true. And no: zooming in on earlier periods doesn’t reveal the kind of anomaly we’ve seen since 2002.

There are two oddities here:

First, the flattening of cumulative savings: this measure was increasing exponentially for decades. Then it slowed significantly starting in the late 90s, and has gone flat to negative since The Great Whatever.

Second, the continued exponential growth of household net worth, and the resulting divergence of the two measures.

But bottom line: Net Worth and the cumulative stock of savings used to move pretty much together. They don’t anymore. What in the heck is going on?

There are three possibilities:

The asset markets are wrong. They’re wildly overestimating the value of our existing stock of real assets, and the output/income they’ll deliver in the future. See: “Irrational exuberance.”

The goods markets are wrong. The market for newly-produced goods and services is setting the prices for newly produced goods below the production’s actual value.

GDP is wrong. We’re producing something that’s not being measured by the BEA methods (tallying up what people spend on produced goods). There’s production the GDP methods can’t see in sales, so it doesn’t show up in saving (production minus consumption). But the asset markets can see it (or…sense it), and they deliver it to households in later periods, through the mechanism of market asset revaluation/capital gains.

Techno-optimists will like this last one. You’ve heard it before: The BEA has no sales-based method for estimating the produced value of free digital goods like Wikipedia, or the utility people derive from using them. They’re not purchased, so the BEA can’t “see” them. They could look at ad dollars spent on Facebook as a proxy for the value of browsing Facebook, but…that’s a pretty shaky estimation method, especially when many of those ad dollars would have been spent anyway, in other media. GDP simply doesn’t, can’t, measure that value, because nobody purchases it.

The timing sure supports this invisible-digital-goods story. The divergence takes off four to eight years after the release of the first mainstream web browser, and the global mainstreaming of the internet in general.

But it’s worth pausing before swallowing that explanation wholesale. You have to ask, for instance:

How does the internet/digital-goods story explain the flatlining of cumulative savings? Shouldn’t that continue to rise, though perhaps not as fast as net worth? Has the internet killed off sales (and accumulation) of traditionally measurable, purchased, goods to the extraordinary extent we see over the last dozen-plus years?

Are the asset markets seeing something else that GDP can’t see? Improved supply-chain management? More-efficient corporate extraction of profits from other other (less-developed?) countries? More-effective suppression of low-end wages? The rising costs of education and health care? (Which the BEA counts as consumption, extracted from saving, even though they’re arguably investment at least in part; they produce very real though intangible and difficult-to-measure long-term value/assets.) Or — here’s a flier — does it have something to do with the Commodities Futures Modernization Act and other financial “liberalizations” passed in the waning days of the Clinton administration? Something else entirely? In particular: would any of these explain the striking trend change in the cumulative savings measure?

Whatever the causes, the divergence of these two measures suggests a rather profound and singular economic shift of late — a shift that is not being widely discussed, even amidst the recent spate of commentary on Piketty’s Capital. (Piketty, by the way, defines wealth and capital synonymously — though his usages are not always consistent.) Prominent exceptions include the economists Joseph Stiglitz and Branko Milanovic, who are actively interrogating the troublesome theoretical intersection of wealth and real capital. The recent divergence of these two national accounting measures suggests that they’re tilling fertile ground for our understanding of how monetary economies work, and how we measure those workings.

Note: Technically one might add (negative) government net worth to the household measure to arrive at national net worth. But: 1. government net-worth estimates are inevitably dicey to meaningless. Government assets (and services) aren’t generally sold in the marketplace, so we have no observable sales information to base our estimates on. Liabilities are also very tricky: estimates vary massively based on your chosen time horizon and (necessarily) arbitrarily chosen discount and economic-growth rates. And 2. It barely changes the picture drawn above. Feel free to add government to the spreadsheet if you want; you’ll find estimates of net worth for the federal, and state/local, government sectors here. Net worth is — as it should be — the bottom line for each sector.

Cross-posted at Angry Bear.

Why You Probably Don’t Understand the National Accounts. In Pictures.

December 24th, 2014 5 comments

If anyone means to deliberate successfully about anything, there is one thing he must do at the outset: he must know what it is he is deliberating about. Otherwise he is bound to go utterly astray. Now, most people fail to realize that they don’t know what this or that really is. Consequently when they start discussing something, they dispense with any agreed definition, assuming that they know the thing. Then later on they naturally find, to their cost, that they agree neither with each other, or with themselves. That being so, you and I would do well to avoid what we charge against other people.

—Socrates, in Plato’s Phaedrus

A recent post of mine, How Do Households Build Wealth?, got a fair amount of attention (even a radio interview) because its takeaway graph seemed to surprise people (as it did me, when I put it together). Here it is again, presented more sensibly as a bar rather than an area chart. Click for larger.

Screen shot 2014-12-18 at 6.12.44 AM

Note: the revaluations shown here are not “realized” capital gains (which really only matter for tax purposes). They’re changes in asset values. If your portfolio’s value goes up by $20,000 this year, that bumps your net worth by $20,000 even if you don’t sell any assets. Ditto your house, but without the second-by-second reporting of prices.

What surprised people: capital gains and losses completely overwhelm Saving (net or gross) when it comes to changes in Net Worth. Here’s an even starker depiction, showing both magnitude and volatility:

Screen shot 2014-12-19 at 8.49.06 AM

I think these graphs are surprising to people because they don’t understand what Saving means in the national accounts, or how it relates to Net Worth. Thinking of households, for instance, many might be surprised to find that:

Starting Net Worth + Saving ≠ Ending Net Worth

Household Saving ≠ Change in Household Net Worth

As you can see in the charts above, it’s not even close. Why? In the national accounts, capital gains/revaluations aren’t counted as part of “Income.” It’s no wonder the Saving/Net Worth equality doesn’t balance; a whole bunch of household “Income” is missing from “Saving.” (Should capital gains be counted as Income and included in Saving? More on that below.)

The somewhat particular, stylized measure labeled “Income” in the national accounts serves an important purpose, but it also makes the word’s meaning opaque and confusing to many. That’s even more true of Income’s residual, “Saving.” The estimable Nick Rowe went so far as to title a post “Why ‘saving’ should be abolished.” Sez Nick: “it’s the most confusing concept in macroeconomics.”

But it doesn’t have to be confusing. The Integrated Macroeconomic Accounts of the United States (IMAs) — based on the modern international System of National Accounts (SNA) — calls out the particularity of “Income” by explicitly labeling the measure “Primary Income” (or more precisely, Balance of Primary Incomes). Drawing on that, the following chart may help render the relationships more transparent, adding a few named measures as aids to understanding.

Household Income
Comprehensive Income (gross contributions to net worth, before netting out expenditures) Non-Property Income (compensation for labor) Other Labor Income Social benefits and other transfers received (including employers’ social contributions)
Primary Income Primary Labor Income: Wages and salaries
Comprehensive Property Income (compensation for ownership) Primary Property Income: Dividends, interest, proprietors’ income, rental income, and operating surplus
Other Property Income Market asset revaluation (capital gains)
Other changes in asset volume

Using these terms, here’s how the national accounts tally up Income and Saving:

Primary Labor Income
+ Primary Property Income
– Interest Paid
= Primary Income

+ Benefits & Transfers
– Taxes
= Disposable Income

– Consumption Expenditures
= Saving (net or gross of capital consumption/depreciation, your choice)

We could call this final measure Primary Saving, because it’s a construct built from Primary Income. I discuss its meaning below.

This all balances, of course, but it’s confusing at least in part because it combines sources and uses of funds into Income, rather than keeping them distinct so Sources = Income. (See Interest Paid and Taxes — both “uses.”) If you’re not holding this whole construct clearly in your head when discussing Income and Saving — and likewise your fellow discussants — you (and they) are probably not adhering to Socrates’ dictum.

A different approach may help. Below is a breakout of Comprehensive Income sources for U.S. households over the last half century, smoothed with rolling ten-year averages to hide confusing noise and make long-term trends apparent. This presentation alters one named measure in the IMAs: Primary Income is displayed before deducting Interest Paid; that’s tallied with Uses, below. Interest Paid comprises 3–7% of Primary Income, 2–6% of Comprehensive Income. Note that everything balances. The spreadsheet’s here. See the balance checks in rows 86–93.

First, sources as nominal dollar values:

Screen shot 2014-12-19 at 9.48.51 AM

And here displayed as shares of the total:

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Next, uses. Note that the total matches the total of Sources, with change in Net Worth as the balancing item. (Net worth is the starting and ending balancing item in the IMA/SNA presentation, which starts and ends with the balance sheet, Assets minus Liabilities.)

Screen shot 2014-12-20 at 10.15.39 AM

And here as shares of the total:

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We could call changes in Net Worth “Comprehensive Saving,” since it’s a residual of Comprehensive Income. I find it to be a more straightforward and easier-to-understand residual than Primary Saving, partly because uses — here taxes and interest paid — are kept separate from the sources. But mainly because:

Comprehensive Income – Expenditures = Comprehensive Saving = Change in Net Worth

A necessary aside at this point:

I’m concentrating on the household sector here because household-sector net worth represents all private-sector net worth. The net worth of all firms is included in household net worth, because households ultimately own all those firms as shareholders or proprietors (or owners of those quasi-“firms,” households that own their homes).

Firms own (pieces of) firms which own (pieces of) firms (America’s founders would aghast at that, by the way), but ultimately households own it all.

You can think of the firm sector here as one big subsidiary of the household sector, with the accounting of its operations and net worth consolidated and telescoped into the accounting statements of their “parent company,” households. Details are obscured in the process, of course. But we’re looking at the big and arguably most important picture here.

By contrast, firms don’t own households. Households don’t issue equity shares — stock — and nobody, including firms, owns shares of, has ownership equity claims against, households. (Run don’t walk to read the Kollin brothers’ The Unincorporated Man.) This asymmetry means you can telescope firms’ value into households’, but you can’t do the reverse. The buck stops at households.

So household net worth comprises all of national net worth except for the net worth of government (plus/minus foreign net net ownership of U.S. assets/liabilities — equalling 1.5–5.5% of U.S. households’ net worth).

A further aside: in this telescoped, consolidated view, almost all household debt is owed to…households: the owners of the lending firms’ assets and liabilities. So this discussion ignores the important issues of lending, borrowing, and debt — important because different households are in different positions. Some (many) households are net debtors in this telescoped view, while others (few) are net creditors because they own the lending firms.

Returning to the key question I asked above: should asset revaluation, capital gains, be counted as income? It depends on our purposes, what we’re trying to display and understand. But the following simplified, stylized scenario may be useful in considering the question:

You buy a company that has a “book,” accounting value of $1 million. You buy it for $1 million. It produces stuff for ten years, makes $100,00 a year in profits, and retains them all. It doesn’t distribute any as dividends. A the end of ten years its book value is $2 million. You sell it for $2 million.

Capital gains: $1 million, with no Primary Income over those ten years. But: all of those gains resulted directly from ongoing profits from production. All of the “revaluation” of the firm as an asset was a result of the company’s increased book value due to retained earnings. The company’s value, and your net worth, increased by $100,000 a year, even if your household didn’t “realize” that by swapping the company for cash. Your annual $100K net-worth increases look decidedly like income from profits (quacks like a duck…), even if those  profits happened to be sequestered off on the books of your wholly-owned subsidiary.

There’s a pretty good case for calling that $1 million in cap gains “income.”

Now of course, not all revaluation/cap gains come from retained earnings and increases in book value. Asset values often go up just because the market has decided that assets are worth more than it thought they were — that they’ll produce more in the future (output and income) than was previously expected.

Here’s a useful way to think about it:

Primary Saving represents the net new stuff we’ve created in the period (the stuff we can count and measure, at least). Produced stuff minus consumed stuff. Net Saving = Net Investment — increases in the stock of fixed assets (and inventories) due to investment spending. We’ve saved in the sense of increasing our stock of stuff.

Comprehensive Saving (change in Net Worth) represents the net new wealth we’ve created. Sources minus uses, income minus (total) expenditures. New wealth ≠ new stuff, because market revaluation of existing stuff (not created within the period) causes wealth/net worth to increase and decrease even as those existing real-world assets remain unchanged. (See: We Have No Idea What Our Capital Is Worth.)

In the big, smoothed, long-term aggregate picture shown here, the market is consistently underestimating the value of current production — the net new created stuff. People are paying less for it than it turns out (in later periods) to be worth. Maybe the market’s undervaluing new human capital, or organizational capital, or future productivity increases, or…who knows. Whatever the case, the market catches on eventually, and (in volatile fits, starts, jumps, and reversals) revalues those previously created assets in later periods. That revaluation of previously produced assets adds to household Net Worth. So at any moment, household Net Worth (“savings,” or wealth — claims on future output) represents the market’s best guess at the value of existing assets and their future output.

When existing-assets markets go up, they quite literally create new wealth (we could call it “money”) out of thin air — new claims on those existing assets — to represent their best guess at the value of those real assets and the output they will produce.

So yes: capital gains are quite reasonably seen as income from production — production in previous periods. Even the parts that aren’t just book value increases due to retained earnings represent the value of production that we didn’t realize we’d produced. The market, in its infinite wisdom, realizes the error and in later periods, delivers that previously-unrecognized production value to households as…income, delivered via the mechanism of capital gains.

Going back to the chart showing income sources as shares of Comprehensive Income: we can see it as depicting the mechanisms whereby we (market and government) deliver and divvy up household income resulting from production. It shows the methods of slicing the production/income pie, and how the methods and slices have changed over time.

The first thing to notice: capital gains (and other volume changes) don’t dominate as they did in the “contributions to net worth” graph at the top of this post. That’s because that graph is somewhat unfair. It posts all household expenditures against Primary/Disposable Income (yielding Net Saving), and posts no expenditures against capital gains. It’s no wonder capital gains appear to dominate; they get a free ride in that picture — going straight to net worth, while Primary/Disposable Income are first drained through expenditures to yield Net Saving.

The Sources graph, by contrast, ignores expenditures; it just shows the Household sector’s sources of funds. Not uses.

This income/sources-only depiction still shows capital gains and other asset-volume changes comprising a significant (and volatile) 15–25% of comprehensive household income. And it displays some familiar features over time:

Compensation for ownership has increased as a share of comprehensive income, from 37% in the 60s to 45% in the decade ending 05/06. (Now recovered to 39% after the 08/09 decline, as ownership gains from recent years overwhelm the 08/09 losses.)

The wages and salaries share has declined from 51% of comprehensive income in the 60s to 40% today. (It’s currently on a four-year downtrend following the brief jump from the 05/06 low of 37% to 44% during the financial crisis.) Benefits and transfers have buoyed total labor compensation over the decades, but not enough to counteract the overall increase in ownership compensation.

That’s all useful and interesting, if not terribly surprising. We see the same results in many other measures. But this accounting construction lets us look at the economy in some other ways that my gentle readers may find valuable. For instance, changes in Net Worth as a percentage of Comprehensive Income:

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Our income keeps increasing (yes, also when adjusted for inflation but of course more slowly). But post-Reagan, a smaller and smaller percentage of it has gone to wealth-building — from 30% in 1980 down to the low twenties in recent decades (and briefly, the low teens). Piketty watchers: what does this mean in the context of his thinking on capital and wealth?

Putting all the uses together in one place (rather than including some of them in the sources) also gives us a clearer picture of expenditures. We can remove the Net-Worth-changes balancing item, for instance, just looking at household expenditures, and see household consumption expenditures as a percent of total household expenditures:

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This measure’s forty-year decline might give pause to economists (notably and vexingly, often liberal economists like Paul Krugman and Jared Bernstein) who pooh-pooh “underconsumption” explanations for The Great Secular Stagnation. (Though the runup over the last 15 years must also be explained.) Item: increased shares for interest payments and social contributions/current transfers were the two big contributors to this measure’s 8% decline (from 81% down to 73%), with each of those shares increasing by roughly 4%.

There are many other interesting depictions, which I’ll save for later posts. Before ending, though, I’d like to share a mental model that may provide a useful way of understanding all this.

Imagine that humans consume something we’ll call money. It’s the only thing they consume. And imagine that our whole economy, all our production processes, just produce money for humans to consume.

Next, imagine that we all produce for a year without doing anything else — no payments of wages, interest, or dividends, no stocks traded, no exchanges of any kind. We just put in 1. labor, 2. real capital services, and 3. natural resources, and money comes out.

We end up with a big reservoir of produced, consumable money at the end of the year.

The next day, the reservoir administrator (let’s call him Walras) transfers that reservoir of money to households. Wages and compensation are paid, dividends are distributed, interest is paid (to households; they’re not spending yet), and people furiously trade stocks, bonds, and houses.

At the end of the day the reservoir is empty; all that produced, consumable money has been divvied into the hands of households. (At this point, household net worth has skyrocketed!)

The next day, households spend. They buy food and other consumables for the year, pay interest to their creditors and taxes to the government, and give some money to the government to hold for them for the future. Whatever’s left over stays into their personal reservoirs of money, increasing their net worth compared to the previous year’s balance.

This stylized picture obviously misrepresents the economy in various ways, through omission at least. But I find it useful, along with the sources-and-uses bookkeeping depicted above, as one way to understand how markets and government divvy up our production pie over the years and decades. I hope others find it useful as well.

Merry Christmas!

Cross-posted at Angry Bear.