6/27/2014 8:51 PM ET|
How the middle class is hobbling the economy
Unless incomes for these Americans can rise along with productivity growth again, the country may suffer a long period of stagnation.
For decades, economic growth in America was driven by a powerful and sustainable force: increased consumption paid for by the rising incomes for middle-class and working-class Americans.
But somewhere around 1980, that model broke down. Wages flattened out, but consumption didn't. Americans cut back on their savings, and took on more debt -- mostly mortgage debt -- to satisfy their needs and desires.
It’s not a sustainable model, but it did persist for nearly 30 years until the credit bubble burst in 2007. Millions of Americans lost their jobs, and millions lost their homes when the credit spigot was shut off, forcing average families to cut back on their consumption and live within their means once again.
And now, with the economy only partially healed, it seems we’re going back to the lend-and-spend economy that failed us before.
For the past six or seven years, most of what the Federal Reserve has done to fix the problem has been focused on getting the credit spigot turned back on: cutting interest rates and hectoring banks to start lending again, even though demand for loans was weak.
It's a surreal policy because, while the proximate cause of the Great Recession was the collapse of borrowing in 2007 and 2008, the ultimate cause was the growth of unsustainable debt over many years, culminating in a doubling of debt between 2000 and 2007.
True, leverage can get you out of a ditch, but it was leverage that got us into that ditch in the first place.
I don't want to sound too moralistic about this. Debt isn't a sin. Borrowing to finance investments that will pay off in the future is smart. Stretching out the payments for things that last a long time, such as homes, cars or appliances, can also make a lot of sense. But borrowing to pay for immediate consumption is usually a dumb idea.
Note also that for the past five years the public and our political leaders have been worried about the wrong debt. They've been intently focused on reducing the federal government’s debt, not on household debt.
We've had a big debate about whether the nation can survive with a government debt-to-GDP ratio above 90 percent, but almost no discussion about what it means for private-sector debt to total 240 percent of GDP.
The broad outline of how private debt destroyed the economy has been known for years. Indeed, economists like Thomas Palley and Dean Baker had been predicting for years that the growth in private debt was unsustainable.
Since the Great Recession, there's been a flurry of research digging deeper into the details, giving us a better idea of just how it played out.
Atif Mian and Amir Sufi's epic "House of Debt" shows that the recession wasn't a banking crisis that could be easily fixed by bailing out banks so they could lend again.
Instead, the crisis was caused by the protracted accumulation of debt by households until it reached a breaking point. And when households could no longer service their debts, it turned into a banking crisis.
Research by economists Barry Z. Cynamon and Steven M. Fazzar links stagnant income growth for middle-class families from the mid-1980s to 2007 and the explosive growth in their debts.
They show that middle-class families were able to maintain their consumption growth only by taking on more debt, which they mostly used to buy homes. As long as house prices were rising, their net worth was increasing, and it seemed sensible to spend some of those riches.
Once the credit spigot was turned off and their wealth was destroyed, consumption by middle-class families plummeted. The anemic recovery can be largely explained by the retrenchment of the middle class.
But richer families -- those in the top 5 percent -- cut back their spending only temporarily, because their consumption was based on steadily growing incomes, not on debt.
Why does this history matter? Because we're treating symptoms, not the disease. We still have an economy that relies too much on leverage by middle-class families, who have made some progress in reducing their debt burden since the recession, but not nearly enough.
Recent data show that the middle class is once again borrowing, mostly for autos and education. Although the cost of servicing their debts has fallen to a record low thanks to low interest rates, middle-class families are vulnerable if interest rates rise significantly.
And that means the economy is vulnerable. In order to grow, our economy requires spending by the middle class because the rich just don’t spend enough to keep the economy moving forward. But how can the middle class spend when their incomes are flat and they are already overburdened with debt?
Unless middle-class incomes can rise along with productivity growth again, the U.S. economy probably is doomed to a long period of stagnation.
More from MarketWatch
If people wanted to buy a house, they had to assume great debt as the housing bubble created upward moves in the pricing of houses! Loans that used to require at least 10% down we replaced by zero down loans, which made it easier to achieve the American Dream. But let us not blame it all on the dreamers who bought the houses! Every one of them believed their own wages would increase, while the cost of goods and services rose in price faster than the incomes, due to new technologies that corporations use to establish the highest possible price for things they sell, while our wages stagnated, and only our workloads doubled! Blame Reaganomics! It is the mantra of the Republican Party, who still, to this day, believe that more money in the hands of the greedy sociopaths will somehow result in them flowering the rest of us with Middle Class high paying jobs! Except it was a lie and remains a lie, and the only winner was a Republican Party, whose fealty to the campaign finances of the corporations, as lapdogs, has provided them with unlimited amounts of funds, while American workers take it in the shorts. Republicans want us to blame Obama, who has no power to pass the bills, like the Republicans who run the House of the worst Representatives this nation has ever known!
Intelligent Americans blame the Republicans. The rest are so ill-informed by the billions of dollars spent on misleading news and information that it is hard to garner the real truth, while so many sources of news are only in it for the money! One look at Fox News, or one listen to Rush Limbaugh or Glenn Beck is enough to make a sane person vomit, but the folksy way they present the news, adding fear and sexual innuendo, is enough to turn the ear of those who probably need that good-paying job the most!
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