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The Great Money Mystery—Solved!

 By   Shlomo Maital

     There is a major economic mystery in Israel, US and the West.

     Governments are running big budget deficits, printing mountains of money, and yet – there is still virtually no inflation, while the inequality of wealth and income has grown alarmingly.

     Why? And — should we worry?  

     I spoke with my friend Arie Ruttenberg about this.   Ruttenberg built Kesher Barel into Israel’s largest advertising agency, sold it to the global McCann-Erickson, founded Club 50 and sold it to Migdal, and wrote a book about creativity with me [Cracking the Creativity Code, 2014]. He has expanded his assets through clever, at times contrarian, investments. Here is his ‘take’ on this mystery.   It takes him 1,267 words to explain – double the length of my usual blog. I hope your investment of time is worth it. I’m pretty sure it is.

       “In the old economy, the money that reached the marketplace was spread among everyone. When they used the money to buy goods, prices rose and this led to inflation. In the new economy, the money reaches only a few of the very rich, who mainly buy stocks, bonds and real estate. These are not included in standard measures of inflation, therefore it seems like there is no inflation.”   

        “Lately, Donald Trump, US President, has boasted about his ability to flood the system with limitless amounts of money and without causing inflation. Really? How can this be understood? There have been a few explanations of this phenomenon, that on the face of it contradict the Keynesian economic model: Huge budget deficits, together with an expansionary monetary policy and zero interest rates, and all this with full employment…and no inflation.   A true economic miracle, that invites other politicians, including some among the Democrats, to offer the nation a Paradise on Earth, of unlimited prosperity through printing money. How did this happen? Is this really sustainable? Or, is it an illusion, with inflation hidden and disguised as something else? And is there a ticking time bomb, very very quiet, a social ‘bomb’ that will result in a deafening explosion soon?”

     “A common explanation for this phenomenon is linked to globalization and technology. The argument is that we are at the dawn of a new macro-economic age, based on enormous global productive capacity and perfect competition through digital trade accessible for all. This explanation is only very partial, because it fails to explain why huge amounts of printed money enter the market and ‘evaporate’ without causing any increases in prices.”

   “My argument is that the budget deficits and the monetary expansion indeed have had an enormous impact, but in contrast with the past, they have not caused significant inflation in consumption goods, but instead have mainly brought a rise in the price of equities, bonds and commercial real estate, which in turn increase economic and social inequality.

       “John Maynard Keynes’ model assumes a uniform economy in which all consumers have similar preferences and compete for the same goods and services, available in limited quantities in the consumer goods markets. In this case, any additional money in the hands of consumers competes for the given amount of goods and so necessarily causes a rise in prices.

       “I propose that we think about consumers, in terms of two groups: a) owners of capital and b) those who earn a living by their labor. Owners of capital earn far more than they need for their subsistence, and they save the difference, mostly by investing in equities, bonds and commercial real estate. These investments continue to expand their incomes, from year to year, but the added income does not necessarily increase their consumption, which is already very high.   The second group, wage-earners or free-lancers who make a living from their wages, spend nearly all their income on their subsistence, and their savings are mostly targeted toward their pensions – that is, future consumption. Ultimately those savings will be almost completely eroded in value.

     The gap between the two groups continues to grow over time, and continually increases the degree of inequality between them.

     “What happens to the economy when the government vastly expands the amount of money? Or when the Central Bank creates huge amounts of credit at zero interest rates?  

      “The answer is: Most of the money and credit flows into the hands of the owners of capital, who grow wealthier as their assets expand, and as they continue to grow their wealth and create more jobs for wage-owners, until the economy reaches full employment. The wealthy grow even wealthier and those who live on their wages earn only enough to barely survive. In this way, the economy reaches full employment, but income and wealth inequality grow.”

      “If the demand for workers grows, why don’t wages rise? Because of the two new phenomena I mentioned, globalization and technology. Through those two forces, we have turned the majority of workers into commodities – that is, into a basic good that has cheap plentiful substitutes. These two forces create a situation in which the supply of labor becomes almost infinite — in economists’ jargon, perfectly elastic. Therefore, when the owners of capital expand their businesses and assets, they do so almost without raising wages at all. When there is full employment, you can always hire cheap foreign workers.

        “And why doesn’t the fall in unemployment bring a major increase in the demand for consumer goods and hence, a rise in their prices?

      “Because of the same two reasons — globalization and technology. Workers can today buy cheaper goods anywhere on earth, via the Internet, and the supply of such goods is becoming nearly infinite. In this way, inflationary pressure in the goods market is prevented.

     “Why doesn’t the rapid growth in incomes of the owners of capital cause inflation, when they spend that income?

      “There are two reasons.   First, because wealthy capitalists cannot eat two steaks for breakfast; and second, because it does cause inflation, but it is not called inflation, it is called “a rise in the stock market” and “a rise in the price of commercial real estate”. Yes, the excess demand caused by the budget deficit and cheap credit creates strong inflation in the main “goods” that the wealthy consume, but because these rises in equity prices and real estate prices are not included in the consumer price index, it is regarded as part of economic prosperity, and not as inflation.”

     “Why do the wealthy people continue to buy stocks, bonds and real estate after they have become so costly?

      “Because the rate of interest is zero, and because there are no other investment opportunities. Thus, the wheel continues to turn, over and over, never stopping, when:   a) the wealthy grow more and more wealthy, pocket trillions of dollars of wealth, and feel super-rich; and b) the wage-earners enjoy full employment, stretch their income to last the full month, and are content. This can be described as the “happiness of the poor”; c) the politicians waste money endlessly and are pleased with themselves; d) the governments expand the debt they owe and nobody cares; e) the central banks expand their balance sheets, and again, nobody cares.   Hallelujah! The messiah has come!

   “Can this go on forever? There is no reason why not, on condition that: a) a few madmen do not arise and start to complain about the social inequality that is becoming unbearable; b) a ‘crazy’ US Central Banker does not appear who starts to raise interest rates, and thus puncture the stock markets, bond markets and real estate prices; c) a stupid American President does not appear who crushes globalization, imports of cheap goods and imports of cheap foreign labor, through trade wars.

   “Then, what happens to the global economy? It becomes an economy of rich feudal lords, and contented vassals who earn exactly as much as they need to go to bed with a full stomach, get up the next morning and to serve their lords. Is this what Paradise looks like?   No, this is what the economics of wealth inequality looks like.

     “At the end of the 1970’s, Israel had a cabinet minister who used the phrase “blessed inflation”, to describe the impact of influence on accelerating economic activity – until, that is, the inflation destroyed the Israeli economy. When the US President brags about flooding the American economy with money in order to create growth, he is boasting in fact about “increasing blessed inequality”.

   “How long will this last? Heaven knows”.

 

 

 

 

  

 

 

 

 

 

 

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Bernie Sanders is Taking the Money Out of Politics

By Shlomo Maital

 Sanders

    Senator Bernie Sanders is running a long-shot campaign for the Democratic nomination for President.  Like all socialists, he has no chance of actually being elected, but very high probability that some of his ideas will be tamed and adopted by his rivals. 

     In today’s New York Times, a strong editorial reveals one other huge gift Sanders brings to the table.  He is raising money the old-fashioned way – one small gift at a time. The average donation to Sanders’ campaign is $31.30.   “It would be hard to buy any politician for $31.30”, says the Times.  Americans of ordinary means have given Sanders 400,000 donations, and 80 per cent of them were less than $200.  Now, contrast that with the fact that 400 of America’s wealthiest families, writing huge checks, account for half the money raised so far by both parties, Republicans and Democrats.  And Trump?  As a billionaire, he pays his own bills… and bought his way into the lead. 

     America’s Supreme Court, notes the Times, in its recent Citizens United decision, “has greatly boosted the buying power of corporate and special interest donors and made a casino frenzy of the (nomination) race”.     The Koch brothers, billionaires, organized 400 of their wealthy friends to create a super war chest of $889 million for Republican candidates.  Jeb Bush raised over $100 m. in big-check donations so far.  Even Hillary Clinton has raised over $20 m. in super-PAC money.

    When democracy is bought by the rich, who invariably seek (and get) favors in return from those whom they help elect,  it is no longer democracy.   So, good for you, Bernie!  Tear a strip off the big donors.  You bring honesty and sanity to this weird campaign. 

Is Money the New Morality?

It is – And That’s Good!

By Shlomo  Maital

Russia capital flight

Really bad things are happening in the world today – and good people seem powerless to do anything about it.  Syria’s Assad bombs civilians.  Russia’s Putin grabs Crimea.  Unspeakable crimes occur in Central African Republic.  And that’s just a start.  The United Nations?  Deadlocked.  Obama?  Words, no deeds.  European Union?  Russia’s gas and Russian oligarchs’ money parked in London dominate. 

    But guess what.  Where good people fail, money succeeds.  Here is how.  When countries like Russia do bad things, money flees.  When money flees, the currency declines, inflation rises and economic growth plummets.  This is happening to Russia, according to the World Bank.  Putin is paying the price — not because of Obama sanctions, but because of market economics.  Here are the figures:

    “… the (World)  bank said Russia’s gross domestic product (GDP) might shrink by 1.8 percent in 2014. …. The Economy Ministry estimates net capital outflow (out of Russia) at up to $70 billion in the first quarter alone, compared with $63 billion in the whole of last year.  … the World Bank envisages capital outflow at $150 billion this year and $80 billion in 2015. This year’s forecast exceeds the $120 billion in capital flight that Russia saw in 2008 during the global financial crisis. … The outflow of money will put further pressure on the rouble, which despite its recent firming is still 7 percent down against the dollar this year.   The weakening of the currency is likely to put upward pressure on inflation, which the World Bank sees at 5.5 percent in 2014, higher than the upper end of the central bank’s targeted range of 4.0-5.0 percent.”  

    So, it’s very simple.  When countries’ leaders do bad things, money flees.  Flight of capital trashes the economy.  People suffer.  They protest.  And eventually, the bad leader leaves, is removed, flees, or is forced to adopt repressive measures, which ultimately fail.  Russia cannot afford to lose $150 b.

   This is the new morality.  Money and capital keep leaders in line, not ethics, values or Obama.   It’s the new ethics of globalization.

    Is it so bad?   The message is:  Run your country properly, treat your people well, or, the money will leave and go elsewhere, where leaders are smarter and more ethical.     And every country needs to keep its capital at home, rather than flee abroad.

    The morality of the new global system is money.  Let’s watch Russia closely to see if it really works.  

  Why Money Should Be Like Manure – But It Isn’t!

By Shlomo  Maital   

                  manure pile 

   Money, it is said, is like manure.  To do any good, it has to be spread around widely.

   But in today’s screwed-up post-global-crisis world,  it isn’t.  Money is increasingly concentrated in a very few hands.  And as a result it just sits there.   This is the nub of the problem.

   Consider these two pieces of data.

   *  A new study by Oxfam, the British philanthropic NGO, claims that  85 super-super-rich individuals in the world hold wealth worth $1.65 trillion!   This amount of wealth, held by fewer than 100 individuals, is equal to the value of all the wealth held by the poorest half of the whole world – 3.5 billion people.   The average wealth of the super-super-rich 85 is $19 b. per person. 

     Try this imaginary exercise.  Suppose, tomorrow, these 85 super-super-rich followed Warren Buffett and Bill Gates and gave away their wealth (gradually selling assets, in order not to depress the prices of stocks, bonds and real estate) and handed the proceeds to the world’s 3.5 billion poor people.  Each poor person would get $471.   This is a paltry sum. But it would change the lives of the poor.  They could start businesses, buy small pieces of land, buy a home.  And this spending would generate income for other poor people, who in turn would spend it…and end the global economic stagnation. 

     Imagine, as John Lennon says.. Imagine.  But it’s just a pipe-dream.  The wealth of the super-super-rich is the opposite of manure.  It sits in their safes and living rooms,  instead of spreading around the world.

   *  According to the Financial Times, Jan. 22,  “the pile of unspent corporate cash that has built up since the start of the financial crisis is being held by an increasingly concentrated pool of companies that will be crucial to hopes of a pick-up in business investment to stimulate the world economy.”   A study by the consulting firm Deloitte shows that globally,  “about a third of the world’s biggest non-financial companies are sitting on most of a $2.8tn gross cash pile of unspent corporate cash (retained earnings) !  And of that sum, fully 5 per cent is accounted for by Apple alone, with $150 b. in unspent cash! ”   “Looking ahead, the wave of cash [spending] that many are expecting will depend on the decisions of a few, rather than the many,” a Deloitte expert said.

  Why aren’t corporations spreading around their cash, like manure?  In a risk-averse world, with sluggish economies, there is no need to invest in more productive capacity.  Better to hold on to the money and play with it than invest it in real industry, in real job-creation, in real innovation.  This is what the handful of rich corporations believes.

    Why not impose a tax on unspent retained earnings, to create an incentive to invest it?  Why reward Apple for holding its cash abroad, instead of investing it in America? 

     So there you have it.   Billionaires and rich corporations. Both sit on huge piles of money.  And the money just sits there.  Until it starts to move, we won’t see true global economic recovery or more new jobs for those who really need them.  

Can China Conquer Its Mountain of Money?

By Shlomo   Maital 

        money mountain                  

   During the global financial crisis, China’s economy should have been hard hit.  As Western economies’ demand for exports collapsed, China should have imploded. But it didn’t.  After a short pause in its growth,  the near-double-digit growth resumed.

   One reason?  China’s Central Bank rapidly and massively expanded the money supply, making credit exceptionally cheap and easy to get.  China’s money supply (M2) grew by 30 per cent at the end of 2009.   Credit growth has slowed but is still very rapid.  M2 grew by 13.6 percent last year, about the same as in 2012 (13.8 per cent). 

    Overall, the amount of money in China has tripled since the end of 2006.  One result has been to create a huge housing bubble and asset inflation.  Hence, buying a very modest apartment in Wuhan, reports Keith Bradsher, in the Global New York Times, now costs about $100,000,  or 14 years of pay at $575 / m. for an average industrial worker.   Unaffordable.

     In the U.S. and U.K., central banks created easy money (quantitative easing) by buying bonds, thus injecting reserves into the system.  It was only partly effective, because banks chose to hold on to the cash rather than lend it, to shore up their ravaged balance sheets.

   In China, monetary policy works differently.  China buys huge amounts of U.S. dollars and Treasury Bonds and Bills, in return for renminbi, to keep the renminbi from growing stronger, and to maintain its undervalued exchange rate at about 6 RMB per buck (it probably be around 3.5,  based on purchasing power).  This keeps China’s exports cheap.   Currency manipulation is illegal, but – not much can be done.  If the U.S. screams too loudly, its multinationals will use their valuable cheap production sites in China and Apple, for instance, could cease to exist. 

    The problem China now faces? How to rein in that mountain of money, and keep it from generating inflation, or keep the housing bubble from bursting when the mountain starts to shrink (or grow more slowly)?   America has failed at a much smaller task – ending Wall St.’s addiction to quantitative easing and free money.  Will China do better?   We should all watch China closely, and hope that wily Zhou Xiaochuan, longtime People’s Bank of China governor, will succeed.  If he fails, we will all feel the pinch.

Blog entries written by Prof. Shlomo Maital

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