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the hard way: lessons learned from the economic collapse

Justice St Rain, June 2009

from economic disparity to economic collapse

It would be easy to learn the wrong lessons from the recent collapse. Those who are too close to the problem see it in terms of housing bubbles and credit default swaps and all sorts of very specific financial instruments. Those who see the big picture accurately name the culprit as greed. Unfortunately, if the only lesson we learn is that people shouldn’t be greedy, we will not have gained any useful insights. A useful lesson needs to fall somewhere between the grand spiritual principle and the specific economic transactions.

Understanding the role that economic disparity played in the collapse – the ever widening gap between the rich and the poor – would give us useful insights that we could apply to personal, national and international policies. It would offer many points of intervention that could gently shift our policies and priorities in new, more healthy and more spiritual directions.

It is clear how economic disparity is a moral question, but how does economic disparity hurt the economy itself? To see the causal connection, we must first understand how a healthy economy works.

What makes an economy healthy and self-sustaining? In a healthy economy, people produce goods and services, they are paid for producing them, and then they go out and buy different goods and services with the money they earn. That’s it. It really isn’t all that complicated.

One of the miraculous aspects of a healthy system is that it can chug along quite nicely without needing to grow or generate excess profits. This is important. It does not have to be driven by a 40-hour work week or constantly increasing consumption. If the needs of the community can be met in 20 hours, then it can stop producing. It doesn’t have to go on to produce twice what people need and then tell them to go buy more stuff. In the developed world, we don’t really need to consume more, but we may need to consume more wisely. There are still some parts of the world, however, in which more is still needed for basic survival. When efficiency and productivity gains provide this increase, then, in a healthy economy, that increase is reflected in wages so that those extra goods can be purchased. What makes an economy healthy is not its size or its growth, but the continuous circular flow of resources.

Excess wealth interrupts this natural flow of resources.

It is not necessary – or even desirable – for everyone in a healthy economy to be paid the same amount, just so long as everyone earns enough to get by, and everyone spends what they earn. The problems arise when a few people are allowed to make so much money that they can’t spend it all. When this happens, then this excess wealth is diverted away from the purchase of goods and services and put into savings instead. This diversion of resources disrupts the natural flow of money through the system, causing it to spiral downward. If goods go unsold, then the companies who hire workers won’t make enough money to pay their wages. Not only that, but these companies will have excess inventory and will have to cut back on production, so they won’t need as many workers. This will reinforce the downward spiral.

Now, before you go out and spend your retirement savings in order to rescue the economy, let me make a distinction between savings and excess wealth. Savings are what you use to send your kid to college, or set aside for a rainy day, or invest to prepare for retirement. It is not excess wealth, it is deferred consumption. It is money that you plan to spend – just not today. If everyone were paid equitably, there would be enough legitimate savings in the system to finance needed ventures. Excess wealth, on the other hand, is money that will never be spent. It is gathered and increased for reasons of status or power or pride. It will be passed on from generation to generation and never reenter the normal flow of commerce. It is this constantly increasing pool of excess resources that eventually overwhelms the financial system.

This excess wealth is money that the rest of us don’t even realize exists. It is hard for us to imagine that there is a glut of savings when we are constantly told that Americans don’t save. Most Americans – indeed most people around the world do not have enough disposable income to save enough to cause even a blip in the flow of the economy. But a few Americans, and a small number of others do have enough savings to disrupt the natural flow of the economy. One of the places that people store their excess wealth, for example, is in stocks. Before the last market crash, Americans had taken over 17 trillion dollars of their savings (150% of our annual GDP) and bought stocks. Of that, the richest 10 percent of American families owned about 85 percent of all outstanding stocks. In addition, they also owned about 85 percent of all financial securities, and 90 percent of all business assets. This means that 85-90% of the savings in the US were accumulated by just 10% of the population. This shows that a significant portion of our nation’s wealth is tied up in savings, and that it is mostly controlled by a very few people. This represents money that is not available to be used to purchase cars, food, clothing, education, medical care or any other part of the real economy. No wonder our economy is struggling. No matter how much the bottom 90% of the population tries to spend, they don’t have a chance of compensating for the 85% of the savings that are pulled out of the system by the rich.

This is obvious. Anyone can see this. So why isn’t anyone doing something about it? Because everyone “knows” that as long as all of that saved money is invested – that is, if people use their excess money to generate even more money– then it goes back into the system as though it were being spent. In other words, people believe that using money is the same as spending money.

It isn’t.

why can’t investment compensate for savings?

There are three primary ways to invest savings – Capital Investment, Loans, and the Stock Market. Each of these is a valuable tool for economic development under the proper circumstances. When the amount invested exceeds the economy's actual needs, however, then each of them can cause more harm than good. Only a few economists¹ acknowledge the dangers of having too much to invest, so let me explain why each of these investment tools ceases to be beneficial when investment exceeds need. Remember, the problem with savings is that it reduces the amount of money that is available to buy goods, which reduces consumption and increases the excess supply of goods. For investments to compensate for these savings in a positive way, they have to help increase consumption, or decrease the over-supply of goods.

capital investment

A capital investment is when you spend money to buy equipment to increase productivity. In a healthy economy, this is a good thing. Perhaps that is why it has been allowed by every major religion. Islamic countries still use investments rather than loans to run their economies. In a healthy economy, when productivity increases, so do wages. Everyone comes out ahead. But in an unhealthy economy, the people who are making the capital investment feel they have a right to the majority of the profits generated by the increased productivity. This means that wages don’t increase along with productivity. More and more goods are produced, but fewer workers have enough money to buy them with. This just makes the problem worse, because if the supply of excess goods increases, then workers will be laid off to compensate.

The economist who originally said that capital investments would compensate for savings modeled his theories on the kind of healthy economic spirit enunciated by Henry Ford: “There is one rule for the industrialist and that is: Make the best quality of goods possible at the lowest cost possible, paying the highest wages possible.” Unfortunately, that spirit no longer dominates business. Since 1975, the rise in America’s GDP (a measure of everything we produce) has been decoupled from rises wages. In other words, we all have produced more, but haven’t gotten paid accordingly. Between 2001 and 2006, for example, productivity in America soared by 16% per worker, while real median wages dropped by 2.9%.²

Today’s economists know this, but they haven’t reformulated their theories accordingly. In today’s economy – where the gap between the rich and poor continues to increase – using savings for capital investments only reduces wages and employment, and diverts more resources away from the healthy flow of the economy and into the hands of the rich.

stocks

Related to capital investment is the purchase of stocks. If you buy new stock, then you are making a capital investment. In a healthy economy, in which the gains of investments are shared equitably, then the stock market is a reasonable way to pool resources and encourage capital investments. In an unhealthy economy, these capital investments create the problems I just described.

When there is too much money in the system, then there is no demand for new capital investments. This means that if you want to buy stock, you have to buy pre-existing stock. In this case, all you are doing is trading one person’s savings for another person’s savings. The terms stock exchange and trading stocks are accurate descriptions of what is going on. No consumption is taking place. It is like a bunch of kids getting together to trade baseball cards. They may be really excited about what great trades they made, but no new cards have been created or consumed. Very few people actually take money out of the stock market, so this money is not being used to buy goods or services. This means that the money sitting in the stock market might as well be stuffed under a mattress, for all the difference it makes in the greater economy. Whether stock prices are up or down, it does not change our ability to consume goods until such time as we actually sell our stock. (It can, however, change our perception of our ability to consume goods, and increase our willingness to borrow against our perceived wealth.)

loans

The third way in which the wealthy use their savings to make more money is through loans. This is potentially the most dangerous and destructive way to use excess savings. It is easy to see why. As the amount that the wealthy have to loan out increases, the amount the poor have with which to pay off those loans shrinks at a compounded rate. There is an invisible line that, once crossed, tips the equilibrium of the economy into a cascading avalanche of bankruptcies, defaults and foreclosures. Since the poor often borrow money in order to repay borrowed money, the line is passed long before the first wave of delinquent payments appear. Perhaps this is why Judaism, Christianity and Islam all forbid charging interest on loans.

Interest charged on loans compounds the gap between rich and poor because it hurts the economy twice – once when the savings are removed from the regular flow of commerce, and again when interest is removed and added to those savings. Let’s start with consumer loans.

Economists say that when savings are loaned back into the economy, they allow people to buy more goods and keep the economy moving. It takes a calculated blindness to believe that a loan and a paycheck will have the same effect on the health of the economy. A loan allows you to buy today with tomorrow’s income, but when tomorrow comes, you will have to pay back both the money and the interest. In the long run, you will end up buying less. This means that if the economy needs consumers to buy more goods, they need to be paid more, not loaned more. But this is not what has happened. As the gap between wages and productivity has risen over the last 30 years, we have been encouraged to make up the difference by going deeper and deeper into debt. What the right hand took away in wages, the left hand returned in loans so that we never realized just how out-of-balance the system was. The long-term consequences were as predictable as they were catastrophic.

Until recently, consumer loans appeared to be a limitless source of free money for the rich. Bankers’ attitude towards plowing excess wealth into consumer debt in order to make a profit seems to have been the same as polluters’ attitude towards putting excess garbage into the ocean: “There is always room for more.” Well, as we’ve discovered, there isn’t. Though the rich seemed to have a limitless supply of money to lend, there was clearly an upper limit to the amount that the middle class could borrow before they became unable to pay off their loans.  For every dollar loaned, there had to be a dollar borrowed. Once a person owes more than they can possibly pay off without sacrificing their health or giving up their first-born child, then they give up and walk away from the loan. This is why the sub-prime mortgage market collapsed.  The rich wanted to make money by loaning to the middle class — forgetting that they had already milked them of any ability to pay their debts. 

There is an old saying: If I loan you $100, that's your problem.  If I loan you a million, that's MY problem.  The rich finally loaned more than they could afford to lose. 

Business loans are a different situation. Business loans at reasonable interest rates are a legitimate way to finance capital investments if they will generate enough profit to compensate for the interest. Nevertheless, as loans, they suffer the same shortcomings as consumer loans when it comes to putting money back into the economy. They have to be repaid with interest, so the net effect is a decrease in the money available for purchases. In addition, loans put into capital improvements create the same problems as any other capital investment if productivity gains are not shared with workers.

conclusion

From this quick analysis, we can see that while it is useful to have a moderate amount of excess wealth available to invest, there is a limit to the amount of excess that the economy can absorb. This simple statement points to a fundamental dilemma. If there is more excess wealth in the system than the economy can safely absorb, what do you do with what is left? Trying to answer that question in a way that puts even more excess wealth in the hands of the already wealthy is what led investors into increasingly risky and sometimes illegal schemes. As Branko Milanovic of the World Bank said:

“Overwhelmed with such an amount of funds, and short of good opportunities to invest the capital as well as enticed by large fees attending each transaction, the financial sector became more and more reckless, basically throwing money at anyone who would take it.”

So if there is no good way to invest this excess wealth, the only logical solution is to find a way to reduce it. In other words, if the rich have more than they can safely use, then for their own sakes and ours, we must find a way to get that excess into the hands of people who can use it effectively – that is, the poor and middle class.

The long-term solution to the world’s economic cycle of boom and bust, then, is to work to reduce the disparity between the rich and poor. This can be done through policies that help increase wages, share profits, and limit or tax excess accumulation of wealth. There is, of course, great resistance to this solution from the wealthy who feel that they deserve all they have and more.

the moral hazards of wealth

Most people are aware of what Jesus says about the dangers of being rich: “It is easier for a camel to go through the eye of a needle, than for a rich man to enter into the kingdom of God.”

The “eye of the needle” was what they called the small door within the larger gate to a city. Once the gate to a city was closed, a traveler could still get in, but his camel would have to crawl through on its knees – showing humility – in order to enter. This means that the rich are welcome in heaven – but only if they are willing to let go of arrogance and show some humility.

The same principle applies today. The real source of our economic problems is not too much wealth, but not enough humility – and the compassion that usually comes with it.

When people become too wealthy, often they try to make sense of their enormously good luck by convincing themselves that they must somehow deserve to be rich, and that others, obviously, do not. The same people who bemoan the entitlement programs that say that everyone is entitled to enough money to survive, often unconsciously believe in an entitlement program that claims that people who already have money are entitled to even more – whether they put forth effort or not. For those rich who do work long hours for their money, there is an irrational belief that their efforts are worth, not two, not ten, but hundreds or thousands of times more reward than the efforts of those who work for them. This is why the CEO’s of companies in the U.S. feel that they deserve to make 261 times the wage of the average worker, and 812 times the minimum wage. One infamous CEO once made 36,000 times more than his lowest paid workers. I’m sure he was a nice guy. But was he worth 36,000 nice guys?

What the ultra-rich fail to see is that it is physically impossible for one person to generate a million dollars in wealth without the assistance of hundreds, or even thousands of other people’s labor. No matter how wonderful one person’s ideas are, or how creative or talented they are, or what wizards of finance they may be, it takes an entire infrastructure in order to bring these ideas, talents or transactions into existence. Each person in that chain is deserving of a share of the wealth. Each person is a soul with needs, dreams and capacities. The conviction that one’s own life is inherently worth more than the lives of these thousands of others is spiritually deadly. It is what allows one person to live in a mansion while surrounded by the starving and homeless. It threatens to destroy the very qualities of compassion and empathy that make us human.

The simple fact is that the rich don’t need all that they have. If they did, they would spend it and we wouldn’t be in this mess. Again, it is the need for power, fame and the intangibles that money bring that cause people to hoard a thousand times a King’s ransom. If these same people were as motivated by intangibles like love, service, honor, compassion, justice, etc. then the world would be a different place.

the author

Justice St Rain is the author of My Bahá'í Faith.

references

[1] For more on this topic, see Revenge of the Savings Glut, an editorial by Paul Krugman, NY Times, March 2 2009, and The Global Saving Glut and the U.S. Current Account Deficit, a talk by Ben Bernanke, March 2005,. and Economy: Root of the Crisis by Branko Milanovic of the World Bank, DailyTimes.com, May 7 2009.

[2] Lane Kenworthy – Professor of Sociology and Political Science, University of Arizona Weblog, “Slow Income Growth for Middle America,” September 3, 2008.

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