" But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room where the clocks have no hands." Warren Buffet
The Reagan Economic Effect
On Thursday, July 17, 1980, Ronald Reagan accepted the Republican nomination for the U.S. Presidency. The acceptance speech was ironically delivered at the Joe Louis Arena in Detroit, Michigan. Detroit, home to the U.S. automotive industry and an example of the pre-and post-World War II manufacturing strength, was about to experience the American middle class's hollowing out in the years to come. During President Reagan's two terms in office, he enacted economic policies (e.g., supply-side economics, lower regulation, debt inducing income tax reductions), which had long-term effects over the next forty years, opposite the expected results in the 1980s. The rise of Reagan started in the 1970s, with the resignation of a President (i.e., Nixon), the dramatic rise in inflation, the effect of the OPEC oil crisis, and the Iran Hostage crisis.1 These events influenced President Reagan's political marketing efforts to re-energize the American public's faith in America's potential greatness. With President Reagan's landslide win in 1980 over incumbent Democratic President Jimmy Carter, the Reagan revolution slowly eroded America's economic strength.2
This essay argues that the current and future direction of the U.S. economy faces headwinds causing future growth to fall below post-World War II averages leading to increased social polarization. The evidence will show that Gross Domestic Production (GDP) growth has continued a consistent downward trend over the last forty years, income inequality has grown, and wealth disparity has expanded. Politicians have not stewarded the U.S. economy with a long-term healthy hand approach.
The organization of this evidence comes in three parts:
Part one outlines the cause and effects of lower GDP growth.
Part two describes the social polarization.
Part three uses a timeline analysis of how U.S. politicians have exacerbated the current and future economic headwinds.
Cause and Effect of Lower GDP Growth
Many factors influence the direction and vibrancy of economic growth. Those factors are demographics, interest rates, inflation, wages, capital goods, service prices, ease of access for growth capital, consumer confidence, infrastructure investment, and political stability. Since the U.S. economy depends on debt to grow, the direction and interest rates are essential to growth trends. Interest rates affect multiple points within an economic system (e.g., cost of capital for businesses and individuals). For example, since reaching a high of 14% in August of 1981, the interest rate affecting borrowing costs of U.S. businesses and individuals has been on a downward trend (i.e., 0.25 August 2021).3 With the lowering cost of borrowing, the incentive for economic participants (e.g., governments, businesses, and individuals) to increase borrowing has led to higher aggregate demand captured in GDP statistics. Since 1980, the U.S. GDP has risen from $2.7 trillion to approximately $21 trillion.4 The evidence reviewing the change in GDP dollar levels and the direction of lower interest implies consistent growth. This growth has come at two costs: (1) the growth trend of GDP and (2) the debt to finance this growth over the last forty years. During 2Q1980, the total public debt as a percent of GDP was approximately 31% and has grown to over 122% as of 2Q2021.5 From reaching a high in the 1950s (2.48%), the average growth rates of real per capita GDP over the succeeding decades has declined to 1.4% (period ending 2017). Even though interest rates have been declining, and GDP growth has numerically increased, the effect of the increased debt trend has been to lower the long-term percentage growth trend.
Another cause for lower future U.S. economic growth arises from demographic influences exacerbating the U.S. debt levels at the federal and state level. Over the last forty years, demographic changes have added to the constraints governments can operate to spur economic growth. For example, the promises of social welfare programs (e.g., Social Security, Medicare, and Medicaid) to the general population, but especially for those over the age of 65, have to be financed with debt. When individuals stop producing income and reduce their savings, a government tax collection begins to decrease. For example, in 2016, the U.S. Census Bureau estimated that 15% of the population would be 65 or older. By 2050, that percentage will increase to 22%. The net result is twofold: (1) social welfare programs costs will increase, and (2) governments will pay for these increased social welfare costs by increasing debt levels as the ratio of working individuals to retired individuals continue to decline.
As the federal and state governments' debt levels increase to provide for social welfare programs, the entire U.S. population and two unique generations (i.e., millennials and Gen Z) must confront personal debt levels at unprecedented levels. For example, total student loan debt in 1Q2006 was roughly $481 billion and had remained roughly stable. At this time, the first wave of millennials began to enter college and accumulate student debt. Over the proceeding fifteens years, millennials and the first wave of Gen Z have accumulated over $1.7 trillion in student loan debt. This annualized growth rate of 8.78% has exceeded the growth rate of starting salaries. These two generations have also experienced faster increases in medical costs, rent costs, and lower salary increases. Unfortunately, these increased student loan debt levels have not increased salaries.
A separate question, unrelated to this paper – What is a college education worth? A more significant issue for future U.S. economic growth – millennials and Gen Z must allocate a more substantial percentage of their salary to student loan debt repayment versus saving or investing compared to previous generations. Lower current savings and investing lead to lower future growth.6 Private debt for the entire U.S. population has also increased faster over the last 13 years than in previous decades. For example, private debt increased annually at 8.4% from 1970 to 2008. But from 2008 to 2021, personal debt has risen by 10.3%.7 The effect of debt increases affects the ability for aggregate demand to increase. The formula for aggregate demand, consumer spending plus investment in capital goods plus government spending plus net exports, can be significantly influenced by changes in consumer spending. Consumer spending approximately equals 66% of the U.S. GDP. This result means aggregate demand sensitivity to consumer spending weighs heavily on consumers' debt service levels. With the continued growth trend of private debt for U.S. individuals and non-productive student debt for millennials and Gen Z, these factors will influence lower future economic growth than in previous decades that did not have these headwinds. The gift of economic headwinds does not stop with debt levels. The current U.S. Personal Savings Rate (defined as personal savings as a percentage of disposable personal income) has ranged over the last decade from a low 4.5% (during the financial crisis) to a high of 33.8% (onset of the countrywide shutdown from Covid-19).8 The effect of the significant personal savings rate during Covid-19 was an outlier data point due to the Federal government increasing debt levels for payouts to individuals affected by the economic hardships from company shutdowns and increased unemployment levels. The important considerations are that though personal savings rates remain relatively range-bound (i.e., 6 to 7%), the private debt levels of individuals continue to increase. This means that should a prolonged economic downturn occur or a slow change of new employment opportunities by external forces (e.g., China, technological changes), U.S. economic growth, so dependent on consumer spending, does not have the savings to maintain spending as during "normal" times. All these data points showcase the fragility of the U.S. economic situation, affecting lower future GDP growth.
Social Polarization - Economic Affects
Social polarization can affect economic growth negatively (e.g., a slow leak from a bucket of water) or positively (e.g., water dripping into a bucket). Unfortunately, the social polarization issues affecting America center on the hole in the leaky bucket of water. For this essay, wealth disparity, income inequality, and technological advances affect employment opportunities falling under the umbrella of social polarization.
Any economy requires citizens to feel or at least retain the hope that the opportunity for growing one's wealth comes with a reasonable probability. This probability needs to include the prospect of fairness. Fairness described that with hard and consistent work, investing wisely (whether through the public capital markets or investing in one own business), and saving consistently, that wealth accumulation can occur. However, suppose a meaningful percentage of the population believes the "cards are stacked against them" from day one. In that case, the incentive to attempt accumulating wealth decreases, thus lowering economic growth or influencing those persons to take from others in the most aggressive situations. Taking from others could be a revolution (e.g., Russian circa 1917) or voting in politicians believing in the broad and deep redistribution of wealth (e.g., Senator and former Presidential candidate Bernie Sanders). The facts of reasonable probability for everyone increasing their wealth has decreased over the last several decades. In 1989 the share of total net worth held by the top 1% was 23.6% and increased to 32.1% by 2021.9 Since the end of the Great Recession, the net worth level of households has more than doubled, meaning the people at the top 1% capture and control a larger share of wealth.10 Like the caveman of yore, humans, like to protect what they have earned. Protection of this wealth means stacking the deck in favor of their families and business dealings. With the internet and social media platforms, the dissemination of current information allows anyone to realize the sad refrain, "The rich get richer, and the poor get poorer." The subtle nature of wealth disparity does not bode well for U.S. future economic wealth and increases one aspect of social polarization.
An economy needs its citizens to believe they can earn an income to provide for themselves and/or their families. At the most basic, this involves food and shelter. In modern economies, especially with the power of social media platforms, citizens are also comparing themselves against others without full details on whether their economic situations genuinely mirror each other. A few sobering statistics from a Pew Research Center in a 2020 report show that between 1970 to 2018, the share of U.S. aggregate income for middle-income earners declined from 62% to 43%. In contrast, upper-income earners increased from 29% to 48%.11 The challenge and risks for increased social polarization are the perspectives of middle- and upper-income earners. The latter feel they have earned the right to their income levels, and the former feel inadequately paid for their work. This perception becomes more entrenched when the top 1% make over 20x the bottom 90% from the same PEW Research Center report from 2020. If income levels remain concentrated within a narrow population range, and a growing percentage of the population feels their income levels are stagnant and unfair -- two outcomes can occur: (1) politicians force a redistribution of wealth thru higher taxes for the upper-income earners, and (2) lower-income earners force a change. The likely option (1) lowers economic growth and stagnant aggregate demand.
New technologies assist in economic growth. However, disruptive technologies that come suddenly or come without the participation of the government to mitigate social disruption (e.g., employment losses) can hamper future economic growth. In previous decades, the U.S. migrated jobs to lower-cost centers (e.g., China, Vietnam, Mexico, India). However, the new technological advances of machine learning, artificial intelligence, and even blockchain technology will have an unknown effect on large portions of the U.S. economy. For example, if technology can read legal documents, notice patterns in the language, cross-reference emails and related financial statements, large swaths of analysts on Wall Street or even blue-chip lawyers at big law firms would be redundant. Not that anyone will shed a tear on those job losses. However, if technology can disrupt jobs at the highest skill levels, what happens to lower-skill jobs such as forklift operations, industrial workers, filing clerks, cashiers, etc.? To date, the U.S. government has not shown an ability to re-train those misplaced by dislocations (e.g., hyper-globalization1980ss, 1990's and 1990's industrial and manufacturing jobs outsourced to lower-priced countries for recent examples). The headwind for the U.S. economy around technological disruptions at all skill levels could affect increases in social polarization and lower U.S. economic growth.
Forty Year Timeline of a Leaderless American Economy
From 1980 to 2020, America has had Republican and Democrat politicians control the legislative and executive branches of government. Yet, in their unique way, each either bowed to their influencers (i.e., lobbyists or individual contributors) or ignored opportunities to take corrective actions for the U.S. economy to regain a solid foundational footing.
1980's: President Ronal Reagan embraced deregulation, lower taxes, increased deficits, and the "me mentality." Deregulation can allow businesses to start up quickly, adding value to economic growth. However, the flip side of deregulation can enable enterprises to sidestep safeguards to protect the environment, food supply, and/or financial stability. For example, Reagan allowed private banks to securitize mortgages. This action opened the floodgates to separate those issuing risk (e.g., banks) from those accepting the risk (e.g., investors). This action culminated in the 2008 Financial Crisis.
Another example is lowering income tax rates. As a result, the upper-income earners experienced a growing trend of disposable income to invest and save, and the lower-income earners experienced the opposite effect. A rising tide (e.g., household wealth and income) did not raise all boats equally.
1990's: President Clinton allowed derivative financial instruments not to be regulated. Not regulating derivatives resulted in the 2008 Financial Crisis and another massive reallocation of wealth from the have's to the have-nots.
Mid 2000's: President Obama missed a generational opportunity after the 2008 Financial Crisis to bring the U.S. economic system back into alignment on taxes, regulation, income, trade, education, and infrastructure.
Over the last forty years, the U.S. economy has grown to unparalleled levels. The leaders of the U.S. economy -- politicians and business leaders -- have gorged themselves on the seemingly endless gifts from this growth. To quote Warren Buffet, "the giddy participants all plan to leave just seconds before midnight," the problem is that the room where everyone exists has a clock with no hour or minute hands. Our leaders seem either ignorant of this fact or believe a solution will appear at the perfect moment when another clock appears with an hour and minute hand. The headwinds for the U.S. economy are only gathering steam: (1) growth of income equality, (2) increasing wealth disparity, (3) declining GDP growth, and (4) politicians afraid of making leadership decisions for the U.S. economy versus their re-election. Perhaps, the news is not all bad. As with the decline and fall of the Roman Empire, new empires rose and fell, mirroring the changing of the seasons.
Perhaps, this is the way of all economic systems.
For advisors using this information provides context for investment decisions. It is no different that our trustee services knowing the history of financial advisors and knowing how to treat financial advisors like celebrities. It's all about context.
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2. Gil, Troy, The Reagan revolution: a very short introduction. (New York: Oxford University Press), 53-62.
3. Federal Reserve Bank of St. Louis. “Interest Rates, Discount Rate for United States from 1980-01-01 to 2021-08-01,” https://fred.stlouisfed.org/series/INTDSRUSM193N, Accessed December 8, 2021.
4. MacroTrends, LLC. “US GDP 1980 to 2021.” https://www.macrotrends.net/countries/USA/united-states/gdp-gross-domestic-product, Accessed December 12, 2021.
5. Federal Reserve Bank of St. Louis. “Federal Debt: Total Public Debt as Percent of Gross Domestic Product from 1980 to 2021,” https://fred.stlouisfed.org/series/GFDEGDQ188S, Accessed December 8, 2021.
6. Dhanya Jagadeesh, “The Impact of Savings in Economic Growth: An Empirical Study Based in Botswana,” International Journal of Research in Business Studies and Management 2, Issue 9 (Septempber 2015): 10
7. Federal Reserve Bank of St. Louis. “Federal Debt Held by Private Investors from 1970 to 2021,” https://fred.stlouisfed.org/series/FDHBPIN, Accessed December 8, 2021.
8. Federal Reserve Bank of St. Louis. “Federal Debt Held by Private Investors from 1970 to 2021,” https://fred.stlouisfed.org/series/PSAVERT, Accessed December 8, 2021.
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Berkshire Hathaway. 2000. "Berkshire Hathaway Inc. Annual Shareholder Letter." https://www.berkshirehathaway.com/letters/2000pdf.pdf/, Accessed November 17, 2021.
Federal Reserve Bank of St. Louis. "Interest Rates, Discount Rate for United States from 1980-01-01 to 2021-08-01. https://fred.stlouisfed.org/series/INTDSRUSM193N, Accessed December 10, 2021.
Federal Reserve Bank of St. Louis. "Federal Debt: Total Public Debt as Percent of Gross Domestic Product from 1980 to 2021. https://fred.stlouisfed.org/series/GFDEGDQ188S, Accessed December 8, 2021.
Federal Reserve Bank of St. Louis. "Federal Debt Held by Private Investors from 1970 to 2021," https://fred.stlouisfed.org/series/FDHBPIN, Accessed December 8, 2021.
Federal Reserve Bank of St. Louis. "Federal Debt Held by Private Investors from 1970 to 2021," https://fred.stlouisfed.org/series/PSAVERT, Accessed December 10, 2021.
Federal Reserve Bank of St. Louis. "Households: Net Worth Level 1987 to 2021," https://fred.stlouisfed.org/series/BOGZ1FL192090005Q, Accessed December 10, 2021.
Federal Reserve Bank of St. Louis. "Share of Total Net Worth Held by the Top 1% from 1989 to 2021," https://fred.stlouisfed.org/series/WFRBST01134, Accessed December 10, 2021.
Jagadeesh, Dhanya. 2015. "The Impact of Savings in Economic Growth: An Empirical Study Based on Botswana." International Journal of Research in Business Studies and Management 2, Issue 9 (September 2015): 10-21.
MacroTrends LLC. US GDP 1980 to 2021. https://www.macrotrends.net/countries/USA/united-states/gdp-gross-domestic-product, Accessed December 10, 2021.
Pew Research Center. 2020. "Trends in Income and Wealth Inequality," https://www.pewresearch.org/social-trends/2020/01/09/trends-in-income-and-wealth-inequality/screen-shot-2020-01-08-at-5-06-47-pm/, Accessed December 10, 2021.
Troy, Gil. The Reagan Revolution: A Very Short Introduction. New York: Oxford University Press. 2009.
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