So I’ve not written in some time as I’ve been busy building out a solution to the common people problems being discussed from the luxurious heights of the Swiss Alps. But as I watch the billionaires, power class and lest we forget Matt Damen and Shakira drink the fine Japanese whiskies and smoke their Cuban cigars whilst staying warm under those fine furs as they so eloquently discuss what is best for us less ambitious people, well I’m drawn to say a few words.
During the Davos event we saw Janet Yellen describe the Fed’s raison d’être. As I’ve said many times before the Fed can only indirectly incentivize spending and productive investment. Ms. Yellen agrees as the following excerpt from yesterday’s speech describes:
“As you may know, the interest rate that we target is the federal funds rate, the rate banks charge each other for overnight loans. Lowering short-term rates in turn puts downward pressure on longer-term interest rates, making credit more affordable–for families, for instance, to buy a house or for businesses to expand.”
What this means is that by making credit cheaper and more available the Fed tries to incentivize consumer spending and domestic private business investment. We can never lose sight of this limitation. And it is a limitation because ultimately no matter how much cheap capital the Fed makes available, consumers may not spend and CEO’s may not invest productively.
It makes good sense then to look at the data to determine how successful the Fed has been incentivizing CEO’s toward productive investments over the past 100 years. There are really only two things that CEO’s can do with available capital. They can put it toward business expansion (fixed investment and human capital) or they can distribute it to shareholders (dividends and share buy backs).
Business expansion is the goal of monetary policy because it has a high economic multiplier. Cash distributions have almost no economic multiplier because 85% of dividends and 100% of capital from buy backs go directly to the secondary financial markets. So let’s have a look at the empirical data to see how the policymakers have done.
The chart takes domestic private fixed investment + labor income (productive investments) and divides it by corporate dividend payouts to shareholders (unproductive investment). In essence it tells us how many dollars of productive capital is being used for every dollar of unproductive capital. What we find is that while the long run average of productive to unproductive uses of capital is around 24x (meaning $24 of productive capital allocation for each $1 of unproductive), today we are only at 9x which is about 20% worse than the years leading into and during the Great Depression.
Perhaps more startling, if possible, is a look at the time series to really grasp the secular failure of monetary policy to achieve its goal of incentivizing productive investment.
This chart is just the time series of the bar chart above. What is clear from this chart is that the failure of the Fed has not been going on for just a few years but it has been going on for 30 years. And while your average person may not know these charts they certainly feel the economic disenfranchisement that these charts depict. And so it is incredibly difficult for your average American to sit and watch those rich and powerful play around in one of the most expensive and exquisite places on Earth whilst once again deciding how they are going to help us little people.
Instead of inviting a bunch of struggling families from across the western world to at least allow us a representative seat at the table, they invite Hollywood stars because famous actors are so much cooler to be around than struggling families. What fascinates me is the hubris of this power class to carry on as though there is some natural law giving them sole rights to be deciding and disseminating economic policy onto the rest of us.
The existing monetary and fiscal policy frameworks are structured to prevent us having any direct involvement (and no, congressional elections every few years doesn’t count as direct involvement). However, it is becoming clear to the masses (refer to the Bernie and Trump movements, to Brexit and so many other ‘populist’ movements) that providing these Davos elites full power of attorney over our economic prosperity has resulted in them being the sole beneficiaries of the system they designed. The wealth gap and income disparity are at record levels. The US is second only to Russia in the gap between median and average wealth, meaning the difference between those on top and the rest of us.
What is so poignant in the above charts is that they very clearly show how the middle class prosperity is being reallocated to those few on top. That is, labor income being reallocated to shareholder cash distributions. This is a gut wrenching and undeniable view of a reverse Robin Hood Effect that has been taking place for too long to be considered a technical error.
Our policy makers have allowed (and many would suggest designed) a system whereby economic capital has literally being taken away from the middle class and handed to the top 5% for more than 30 years. The moral repugnance and mathematical ignorance permeating our economic system has now moved to levels never seen before in modern history.
All the while the policy makers continue to inform us from their luxurious suites that their intent is to help us little people. The problem with their stated objectives is that effectively all empirical evidence suggests otherwise. In the end, these people have either lied to us or are completely ignorant of the problem and thus any hope for solution is impossible. That is, unless we begin to understand they have no natural exclusivity to economic policy making.
Beyond the moral reprehensibility of a reverse Robin Hood Effect, why should CEO’s and shareholders also be concerned about this secular misuse of capital? Well let’s take a look.
Ultimately this hits all stakeholders in the economy. Why? Well as individual’s financial wherewithal declines so too does their ability and propensity to spend. The next chart will provide some clarity around the link between the reverse Robin Hood Effect and stalling top lines of the S&P.
The above chart overlays personal consumption growth per capita onto the time series chart above. Essentially it depicts the relationship between the deterioration of productive uses of capital and an individuals rate of consumption growth. This is despite the massive income subsidization from credit and welfare and the above relationship is mathematically guaranteed. This is why even shareholders and CEO’s should be concerned about the gross and secular misuse of capital in our economy.
To really drill this home for these profit focused stakeholders let’s look at price to sales of the S&P 500.
These are the top lines of the S&P 500 beginning to flat line and actually roll over. So either valuations have to continue to stretch or equities end up taking a bath at some point because ultimately everything comes back to that thing that is 70% of the economy, i.e. personal consumption expenditures (PCE). And while you can supplement incomes for a time the ugly reality is that marginal propensity to spend will continue to decline unless labor incomes move higher. It is a mathematical certainty.
So then if the Fed has done the only thing it can do in terms of incentivizing productive investments but has failed fundamentally to get the job done, well what do we do? We can rely on fiscal policy, which does have some possibilities like reducing the relatively very high corporate tax rate. But are fiscal and monetary frameworks our only options to affect economic policy? We’ve certainly come to believe that they are. But what if I was to suggest they aren’t? Let’s do a quick thought experiment.
If I was to say let’s create a new economic policy framework where would we start? We would want it to be as potent as possible meaning whatever the mechanism is to affect changes in the economy we would want that to have a high delta on the underlying economy. And because we know that PCE is the most potent force in the economy by a multiple of at least 3x perhaps we try to build a framework around it.
You see consumer spending drives 70% of the economy but it doesn’t have direct input in setting economic policy for some reason. What if we created a platform that could take this incredibly powerful passive force and turn it into an active force? Think of it like a large mountain lake. That lake is a potential force meaning it is an incredible amount of mass that, in its current state, isn’t being used. But if you knock out a valley wall and build a damn you now activate the power by creating a flowage around the tremendous mass. And that mechanism powers entire cities like Las Vegas and New York.
And so what if we took the massive but passive power of consumer spending and turned it into a flowage toward a particular macroeconomic objective? Wouldn’t that be a new and most powerful economic policy framework? In fact, if 70% of the economy was able to set and continuously reinforce its chosen policies through daily consumer spending is there any other force or stakeholder in the economy that could match its efficacy?
We’ve added $10T in public debt and $4T in private debt over the past 8 years to achieve productive capital allocations and have gotten no return. Isn’t it time to acknowledge the limitations of existing economic policy frameworks? Isn’t it time to develop a new more mathematically viable and morally justifiable economic policy platform? Of course it is.