Free People, Free Markets

Quote from the WSJ celebrating its 125th anniversary:

The answer to our current slow growth and self-doubt isn’t a set of magical “new ideas” or some unknown orator from the provinces. The answer is to rediscover the eternal truths that have helped America escape malaise and turmoil in the past.

These lessons include that markets—the mind of free millions—allocate scarce resources more efficiently and fairly than do committees in Congress; that the collusion of government with either big business or big labor stifles competition and leads to political cynicism; that government will be respected more when it does a few things well rather than too many poorly; and that innovation and human progress spring not from bureaucratic elites but from the genius of individuals.

Above all, the lesson of 125 years is that whatever our periodic blunders Americans have always used the blessings of liberty to restore prosperity and national confidence. A free people have their fate in their own hands.

US Dollar Value under Management by the Federal Reserve

Eye-opening graph.

Fed advocates will argue that dollar depreciation over this period has also led to more than twenty times growth in wages and incomes. But the uncertainty of currency values does not affect all sectors uniformly and arbitrarily creates winners and losers. So, the growth in incomes has come at the expense of savers and older Americans living on fixed income pensions. It has greatly favored those who have done little except borrow to buy financial assets and real estate. So the question is: do we want an economy of ‘four walls and a roof’ or one of productive factories? The first is a depreciating asset, the second an appreciating asset.

As James Rickards puts it in his book, Currency Wars: “The effect of creating undeserving winners and losers is to distort investment decision making, cause misallocation of capital, create asset bubbles, and increase income inequality. Inefficiency and unfairness are the real costs of failing to maintain price stability.”

More pointedly he writes:

The U.S. Federal Reserve System is the most powerful central bank in history and the dominant force in the U.S. economy today. The Fed is often described as possessing a dual mandate to provide price stability and to reduce unemployment. The Fed is also expected to act as a lender of last resort in a financial panic and is required to regulate banks, especially those deemed “too big to fail.” In addition, the Fed represents the United States at multilateral central-bank meeting venues such as the G20 and the Bank for International Settlements, and conducts transactions using the Treasury’s gold hoard. The Fed has been given new mandates under the Dodd-Frank reform legislation of 2010 as well. The “dual” mandate is more like a hydra-headed monster.

From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95 percent of its value. Put differently, it takes twenty dollars today to buy what one dollar would buy in 1913. Imagine an investment manager losing 95 percent of a client’s money to get a sense of how effectively the Fed has performed its primary task.

There is also an implication in the pro-Fed position that gradual inflation is necessary in order to grow the economy – an analogy to greasing the machine. But that is conjecture and disproven by robust growth during the latter half of the 19th century while we experienced mild deflation.  As I have argued in Common Cent$, economic growth is a function of technology and population growth through increased labor productivity. Manipulating price values through monetary policy does little to promote long-term stable growth and only aggravates unfair economic inequality. It seems it takes a long time for each generation to discover this truth.

Federal Reserve Gone Wild

From a report by First Trust Advisors, Brian Wesbury, Chief Economist:

The Fed has massively increased the size of its balance sheet, from roughly $850 billion in 2008 to its current $3.96 trillion. Quantitative Easing was accomplished by having the Fed buy bonds and pay for them by “creating” excess bank reserves – reserves above and beyond those that are required.

Now it looks like the Fed will finish tapering and then raise interest rates without shrinking its balance sheet. In this way, the Fed is behaving like any other government agency, not wanting to shrink again after growing during a crisis. But, in order to make this work, the Fed will eventually have to pay banks a high enough interest rate to incentivize them to keep excess reserves from turning into inflationary money growth.

However, not just banks hold reserves. Fannie Mae, Freddie Mac and some Federal Home Loan Banks hold reserves, too. But the “Financial Services Regulatory Relief Act of 2006,” only gave the Fed the legal right to pay interest on balances “maintained at a Federal Reserve Bank by or on behalf of a depository institution.” In other words…by law, the Fed can’t pay Fannie Mae or the others interest on reserves.

As a result, the money the Fed has injected into these institutions is a potential source of inflation if they lend their reserves to banks. So the Fed has dreamed up a new program of “reverse repos,” where it temporarily lends GSEs (and some money market funds) Treasury bonds with a promise to buy them back at a higher price in the future.

The price difference is an implied interest rate and by doing this the Fed is paying a higher rate today than these institutions can earn by buying 1, 3, or 6-month T-bills. The Fed is trying to mop up excess liquidity in the system so the money supply doesn’t inflate.

But this flouts the law written by Congress. In effect, by coloring outside the legal lines, the Fed is paying interest on reserves to “non-banks.” The Fed hopes this operation lets it have its cake (a large balance sheet) and eat it too (no rapid money growth).

In addition to undermining the rule of law, the practice is fraught with danger. If profitable lending opportunities accelerate, then, as the Fed tries to mop up excess reserves, it will be forced to raise interest rates higher and higher as an incentive for banks not to lend. Otherwise, if banks feel they can lend money to the private sector more profitably than they can lend to the Fed, they will not participate in the repo market.

This can cause the equivalent of an “arms race” in the financial system, where interest rates must be raised faster and further than the markets want in order to keep the lid on inflation and bank lending.

Rather than flout the law, the Fed should be looking for ways to unwind QE. It’s time has come and gone. The Fed is too big – much bigger than Congress (The Law of The Land) ever wanted.

—————

We should see that the only choices available to the Fed are 1) to raise interest rates high enough to mop up excess reserves and risk economic stagnation, or 2) to lose their grip on inflation. Mostly likely we will get a combination of both, which we know as stagflation. A sharp correction is the only remedy, and the longer it is avoided, the larger and steeper it will eventually be.

 

Preparing for the Apocalypse?

Federal Reserve policy must seem pretty arcane to most people, which is why I try to liven it up with a bit of sarcasm and wit. There was a lead article in this week’s Barrons illustrating how the public equity markets are shrinking (instead of the Wilshire 5000, it’s now the Wilshire 3666). Here is the lead-in:

As companies find other ways to raise cash, number of U.S. stocks keeps shrinking.

The writer then summarizes an explanation:

Why has the universe of investible U.S. stocks shriveled so? Globalization, porous borders, and the rise of foreign markets have siphoned away a few U.S. listings. Mergers and bankruptcies have exacted a toll. Increased regulation and the climbing costs of a public listing have weakened the resolve of managers who once dreamt of ringing the opening bell at the New York Stock Exchange. At the same time, zealous private-equity buyers and zero interest rates are making it all too easy for companies to raise money without going through the pantomime of public compliance.

This should really surprise no one who’s aware of the impact Fed policy has upon the structure of our economy. Think about it: you start a business with a little capital saved up. If you’re successful and your business grows you need more and more capital, either from the bank, from venture capitalists, private equity firms, or public equity and credit markets (by issuing stocks and bonds). The costs of these different financing options varies. Borrowing at a reasonable or low rate allows one to retain the equity and leverage the profits and value of the enterprise. (This is how one gets into the 1%)

However, if borrowing is dear, growing firms will use public equity markets to spread risk and give up a proportionate amount of return. But Fed policy over the past 20 years has essentially assured business owners that monetary policy will serve to prop up business and equity values with limitless liquidity. That’s what the Fed’s Zero Interest Rate Policy does by keeping interest rates low. (Quantitative easing buys up bad mortgages from the banks so they can get back into the business of making loans, but who wants to make loans when you can make risk-free returns by buying Treasuries and lending to the government?)

So where’s the risk and the imperative to give up equity profits to share that risk? Essentially, the Fed has given businesses and speculators free insurance and leveraged them up with cheap credit. The taxpayers provide the guarantees by absorbing any losses with bailouts.

So, as the article explains, we see private equity and share buybacks shrinking the participation of the public in the profits of capitalism. Why give up equity if there is no risk? It is my opinion that Fed policy is accelerating the imbalances in our market society to unsustainable levels. And the politicians merely think the headline numbers show what a great job they’re doing. The Obama administration is touting the bubbling stock market as proof of how great their policies are working for America. Really? They should think about this: a permanent zero or negative real interest rate essentially means There. Is. No. Tomorrow. Great, shall we call it the Apocalypse policy?

Sailing on Oceans of Liquidity

Quoted from this weekend’s Barron’s interview with legendary trader, Jim Rodgers:

This is the first time in recorded history that we have all the major central banks, all the major governments actively debasing their currencies. Japan has said it will print unlimited amounts of money. So Ben Bernanke said, “Wait a minute, we can throw in a trillion dollars a year.” And the Europeans said they’ll do “whatever it takes.” There’s a gigantic ocean of liquidity, and the people getting that liquidity are having a wonderful time. But it’s totally artificial, and it’s going to end badly when it ends, I assure you.

[No inflation?]

According to the U.S. government! But you must buy some things: insurance, food, even paper. The price of nearly everything is going up. We have inflation in India, China, Norway, Australia—everywhere but the U.S. Bureau of Labor Statistics.

I’m telling you they’re lying. Go to a restaurant in New York, or a grocery store, and tell me that there’s no inflation. Look here: In 2001, it cost $9 to go to the top of the Empire State Building. Now it’s $27 to go to the 86th floor, $44 to go to the top, and $67 to go express. The Museum of Modern Art in 2001 was $10, now it’s $25. A cab from Kennedy airport to Manhattan in 2001 was $30 plus tolls. Now it starts at $52.

While we do not see general price inflation as defined by the US Bureau of Labor Statistics, we see radical relative price changes across goods and services. Those sellers with pricing power have raised prices steeply over the past few years and the price changes will continue under this central bank regime. The prices that will not go up are the COLA adjustments on wages and Social Security.

The Theater is Burning

But nobody is going to yell, “FIRE!”

The Shutdown Is a Sideshow. Debt Is the Threat

An entitlement-driven disaster looms for America, yet Washington persists with its game of Russian roulette.

 By NIALL FERGUSON

In the words of a veteran investor, watching the U.S. bond market today is like sitting in a packed theater and smelling smoke. You look around for signs of other nervous sniffers. But everyone else seems oblivious.

Yes, the federal government shut down this week. Yes, we are just two weeks away from the point when the Treasury secretary says he will run out of cash if the debt ceiling isn’t raised. Yes, bond king Bill Gross has been on TV warning that a default by the government would be “catastrophic.” Yet the yield on a 10-year Treasury note has fallen slightly over the past month (though short-term T-bill rates ticked up this week).

Part of the reason people aren’t rushing for the exits is that the comedy they are watching is so horribly fascinating. In his vain attempt to stop the Senate striking out the defunding of ObamaCare from the last version of the continuing resolution, freshman Sen. Ted Cruz managed to quote Doctor Seuss while re-enacting a scene from the classic movie “Mr. Smith Goes to Washington.”

Meanwhile, President Obama has become the Hamlet of the West Wing: One minute he’s for bombing Syria, the next he’s not; one minute Larry Summers will succeed Ben Bernanke as chairman of the Federal Reserve, the next he won’t; one minute the president is jetting off to Asia, the next he’s not. To be in charge, or not to be in charge: that is indeed the question.

According to conventional wisdom, the key to what is going on is a Republican Party increasingly at the mercy of the tea party. I agree that it was politically inept to seek to block ObamaCare by these means. This is not the way to win back the White House and Senate. But responsibility also lies with the president, who has consistently failed to understand that a key function of the head of the executive branch is to twist the arms of legislators on both sides. It was not the tea party that shot down Mr. Summers’s nomination as Fed chairman; it was Democrats like Sen. Elizabeth Warren, the new face of the American left.

Yet, entertaining as all this political drama may seem, the theater itself is indeed burning. For the fiscal position of the federal government is in fact much worse today than is commonly realized. As anyone can see who reads the most recent long-term budget outlook—published last month by the Congressional Budget Office, and almost entirely ignored by the media—the question is not if the United States will default but when and on which of its rapidly spiraling liabilities.

True, the federal deficit has fallen to about 4% of GDP this year from its 10% peak in 2009. The bad news is that, even as discretionary expenditure has been slashed, spending on entitlements has continued to rise—and will rise inexorably in the coming years, driving the deficit back up above 6% by 2038.

A very striking feature of the latest CBO report is how much worse it is than last year’s. A year ago, the CBO’s extended baseline series for the federal debt in public hands projected a figure of 52% of GDP by 2038. That figure has very nearly doubled to 100%. A year ago the debt was supposed to glide down to zero by the 2070s. This year’s long-run projection for 2076 is above 200%. In this devastating reassessment, a crucial role is played here by the more realistic growth assumptions used this year.

As the CBO noted last month in its 2013 “Long-Term Budget Outlook,” echoing the work of Harvard economists Carmen Reinhart and Ken Rogoff: “The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. . . .

“At some point, investors would begin to doubt the government’s willingness or ability to pay U.S. debt obligations, making it more difficult or more expensive for the government to borrow money. Moreover, even before that point was reached, the high and rising amount of debt that CBO projects under the extended baseline would have significant negative consequences for both the economy and the federal budget.”

Just how negative becomes clear when one considers the full range of scenarios offered by CBO for the period from now until 2038. Only in three of 13 scenarios—two of which imagine politically highly unlikely spending cuts or tax hikes—does the debt shrink from its current level of 73% of GDP. In all the others it increases to between 77% and 190% of GDP. It should be noted that this last figure can reasonably be considered among the more likely of the scenarios, since it combines the alternative fiscal scenario, in which politicians in Washington behave as they have done in the past, raising spending more than taxation.

Only a fantasist can seriously believe “this is not a crisis.” The fiscal arithmetic of excessive federal borrowing is nasty even when relatively optimistic assumptions are made about growth and interest rates. Currently, net interest payments on the federal debt are around 8% of GDP. But under the CBO’s extended baseline scenario, that share could rise to 20% by 2026, 30% by 2049, and 40% by 2072. By 2088, the last date for which the CBO now offers projections, interest payments would—absent any changes in current policy—absorb just under half of all tax revenues. That is another way of saying that policy is unsustainable.

The question is what on earth can be done to prevent the debt explosion. The CBO has a clear answer: “[B]ringing debt back down to 39 percent of GDP in 2038—as it was at the end of 2008—would require a combination of increases in revenues and cuts in non-interest spending (relative to current law) totaling 2 percent of GDP for the next 25 years. . . .

“If those changes came entirely from revenues, they would represent an increase of 11 percent relative to the amount of revenues projected for the 2014-2038 period; if the changes came entirely from spending, they would represent a cut of 10½ percent in non-interest spending from the amount projected for that period.”

Anyone watching this week’s political shenanigans in Washington will grasp at once the tiny probability of tax hikes or spending cuts on this scale.

It should now be clear that what we are watching in Washington is not a comedy but a game of Russian roulette with the federal government’s creditworthiness. So long as the Federal Reserve continues with the policies of near-zero interest rates and quantitative easing, the gun will likely continue to fire blanks. After all, Fed purchases of Treasurys, if continued at their current level until the end of the year, will account for three quarters of new government borrowing.

But the mere prospect of a taper, beginning in late May, was already enough to raise long-term interest rates by more than 100 basis points. Fact (according to data in the latest “Economic Report of the President”): More than half the federal debt in public hands is held by foreigners. Fact: Just under a third of the debt has a maturity of less than a year.

Hey, does anyone else smell something burning?

How Finance Goes, So Goes the Nation

From the WSJ:

The Government Won on Financial Reform

The financial system is more regulated than ever, but also no safer.

‘Your No. 1 client is the government.” So former Morgan Stanley CEO John Mack told current CEO James Gorman in a recent phone call, according to a September 10 story in the Journal. He’s exactly right, which more or less sums up how American finance has evolved in the five years since the 2008 financial crisis. Far and away the biggest winner is the government.

This isn’t the conventional view in media and politics, where the spin is that Wall Street has triumphed. This is politically convenient because it maintains Washington’s self-serving fiction that the banks alone caused the crisis, and that after bailouts they have emerged richer and less regulated than ever. This leaves politicians free to bash the banks in perpetuity even as they constrain their business and fleece them at regular intervals.

The truth is that across the U.S. economy the government has far more power than it did five years ago, especially in finance. The same politicians and regulators who pulled every lever they could to force capital into mortgage finance have not only escaped punishment for their role in the 2008 crisis. They’ve also awarded themselves more authority to allocate credit. Consider some prominent realities:

• Most of the big banks survived, but at the price of becoming regulated utilities. A sensible reform would have been to require more capital as a bumper against losses, and to use a basic definition of capital that can’t be gamed. Instead, the regulators are requiring more capital while adding vast new layers of regulation.

The regulation micromanages bank decisions down to the kind and quality of loan. Regulators have ordered a top-to-bottom overhaul of foreclosure processes even after extorting more than $25 billion in payouts for exaggerated past offenses.

The Consumer Financial Protection Bureau can veto some products while all but dictating certain kinds of lending. The bureau already has 1,297 employees and an automatic budget tied to Federal Reserve System expenses, not to Congressional appropriations.

The Dodd-Frank Act’s great reform conceit is that the same regulators who missed the last crisis, and who tolerated Citigroup’s off-balance-sheet vehicles hiding in plain sight, will somehow prevent the next crisis. It won’t happen. Regulators somehow missed J.P. Morgan’s “London whale” trades even after they were reported in this newspaper. But they sure know how to punish ex post facto, extracting $920 million in a settlement with J.P. Morgan this week.

• The policy of too big to fail has been codified and expanded. Dodd-Frank lets Washington’s wise men define “systemically important” institutions subject to stricter regulation, and they are dutifully expanding this safety net. Insurance companies are already in this maw (AIG, Prudential) or may be soon (MetLife). So are clearinghouses for derivative trades, which have emergency access to the Federal Reserve’s discount window.

Dodd-Frank’s second great conceit is that in a crisis these firms will be wound down without a rescue. They even have to provide “living wills” that are supposed to plan the funeral. But the law also gives regulators the freedom to protect creditors as they see fit, which they will surely do in a panic. The difference next time will be that more firms will be deemed too big to fail.

• The government roots of the crisis are unreformed, especially easy credit and the bias for housing. The Federal Reserve keeps buying mortgage securities to lift housing prices. Fannie Mae and Freddie Mac continue as ever, even after losses resulting in $188 billion in bailouts. Taxpayers now guarantee close to 90% of all new mortgages either through Fan and Fred or the Federal Housing Administration, which may also need a bailout.

Now that Fan and Fred are making money again amid the housing recovery, political pressure is growing to release them from federal conservatorship. This would recreate the same toxic mix of private profit and public risk that made them so dangerous when we were warning about them a decade ago.

Dodd-Frank did mandate that credit-rating agencies be reformed, but regulators still haven’t finished the job. The same goes for money-market mutual funds, which continue to benefit from a government rule that lets them declare a $1 net asset value even if the value of the underlying assets has changed. This is systemic risk caused by government that government could but won’t fix.

Even the new Basel capital standards are suspect because they include a carve-out for sovereign debt. So the same regulators that claimed mortgage debt was AAA safe now say that debt from various governments is solid gold.

The simpler, better reform would have been to require much tougher capital standards for banks that take insured deposits, set clear rules that limit risk-taking at such institutions, and let other companies innovate and take risks knowing they get no taxpayer protection. Instead, five years after the panic we have a financial system that is more heavily regulated, and thus is less able to lend and innovate, yet is paradoxically no safer. The government won again.

Hedge Fund Myth

This is just a hilarious graphic by Businessweek for its article titled “Hedge Funds are for Suckers.”  Full article here.

BTW, we’ve created the hedge fund industry with our easy credit policies that have only increased volatility and trading in asset markets. Like the blog says, it’s a casino…

Will the Fed Do the Right Thing?

From the WSJ:

The Fed Should Start to ‘Taper’ Now

There’s little chance that more bond-buying will help the economy. Meanwhile, the financial risks are growing.

By MARTIN FELDSTEIN

The Federal Reserve should begin now to end its program of long-term asset purchases. It should not wait for the improved labor market that it predicts will come later this year, an improvement that is unlikely to occur. Instead, the Fed should emphasize that the pace of quantitative easing must adjust to the likely effectiveness of the program itself, and to the costs and risks of continuing to buy large quantities of bonds.

Although the economy is weak, experience shows that further bond-buying will have little effect on economic growth and employment. Meanwhile, low interest rates are generating excessive risk-taking by banks and other financial investors. These risks could have serious adverse effects on bank capital and the value of pension funds. In Fed Chairman Ben Bernanke’s terms, the efficacy of quantitative easing is low and the costs and risks are substantial.

At his June 19 press conference, Mr. Bernanke described the Fed’s plan to start reducing the pace of bond-buying later this year and to end purchases by the middle of 2014. He stressed that those actions are conditional on a substantial improvement in the labor market, leading to an unemployment rate of about 7% by mid-2014 with solid economic growth supporting further job gains. He emphasized that the “substantial improvement” would be judged by more than the unemployment rate.

Over the past year, unemployment has declined to 7.6% from 8.2%. However, there has been no increase in the ratio of employment to population, no decline in the teenage unemployment rate, and virtually no increase in the real average weekly earnings of those who are employed. The decline in the number of people in the labor force in the past 12 months actually exceeded the decline in the number of unemployed.

These poor labor-market conditions are unlikely to improve in the coming months. The Fed’s forecast of substantial employment gains rests on the assumption that real GDP will grow by about 2.5% during the four quarters of 2013 and by more than 3% in 2014. That would represent a substantial rise from the growth rates of less than 2% in 2012, 1.8% in the first quarter of 2013, and a likely 1.7% in the second quarter. Reaching the Fed’s GDP forecast for this year requires the growth rate to jump to more than 3% in the third and fourth quarters.

It is difficult to see how this can happen. U.S. exports are declining in response to weaker growth in other countries and a stronger dollar. The sequester and the higher tax rates that took effect on Jan. 1 will continue to reduce aggregate demand. These forces will more than offset the favorable but small effect on GDP from increased residential investment.

Corporate profits and nonfarm inventory investment declined in the first quarter, and nonresidential fixed investment was essentially unchanged. Spending by state, local and federal governments fell. Personal income declined and after-tax personal income declined even faster. The growth of GDP was sustained primarily by a faster pace of consumer spending that will be hard to maintain with stagnant earnings and a household saving rate that has dropped to only 3.2%.

The higher interest rates that followed the Fed’s announced plans for tapering its bond-buying will further weaken GDP and employment. This will make it even more difficult for the Fed to achieve the robust labor market it says is necessary to scale back the bond purchases.

The Fed is also understating the impact of its tapering plan on interest rates. Mr. Bernanke has made it clear that he believes the level of long-term interest rates depends on the total stock of bonds held by the Federal Reserve, and not on the monthly rate of purchases.

But the planned shift from the current monthly bond purchases of $85 billion to zero over the next 12 months clearly had a large impact on long-term rates, pushing them to levels not seen since July 2011. This impact is hard to explain by any effect the tapering might have on the ultimate size of the Fed’s bond portfolio. Mr. Bernanke admitted in his June 19 press conference that the very large jump in rates that has occurred was therefore a “puzzle.” [Wrong again, Ben?]

The sudden jump in rates suggests that the Fed’s statements acted as a “trigger” indicating that the low-rate equilibrium was coming to an end. Market participants have recognized that the interest rate on long-term Treasury bonds is unsustainably low. The real level of 10-year rates was negative until a few months ago and is now only slightly positive.

That real rate would normally be at least 2%. Given the size of the fiscal deficit, the relative size of the national debt, and the low rate of household saving, the real rate should now be significantly higher. Investors nevertheless continued to hold long-term bonds to gain a bit more yield, hoping they would be able to exit quickly before higher interest rates caused asset prices to fall.

Mr. Bernanke’s congressional testimony at the end of May and again in June may have been the trigger that caused portfolio investors to start selling bonds, just as the observed problems with subprime mortgage securities triggered a much wider selloff in 2007. If so, long-term interest rates are likely to go higher.

Although interest rates have increased, they are still abnormally low. Investors and financial institutions are still accepting significant risks in order to enhance the yield on their portfolios by buying low-quality corporate bonds, holding longer-term bonds, making covenant-light loans that increase the risk to lenders by imposing fewer restrictions on borrowers. They are also bidding up prices of agricultural land and other assets.

The danger of mispricing risk is that there is no way out without investors taking losses. And the longer the process continues, the bigger those losses could be. That’s why the Fed should start tapering this summer before financial market distortions become even more damaging.

‘Winner Take All’ Economy Mirrors Music Industry

The issue of the Winner-Take-All economy was raised by economist Alan Krueger in a speech at Cleveland’s Rock and Roll Hall of Fame. Krueger explains how globalization and technology are the two major forces driving income and wealth inequality in the world today. Unfortunately, Krueger identifies the cause, but completely fumbles the solution.

The maldistribution of the gains from globalization and technology cannot be solved by increasing wage incomes because the major driver of the increase in wealth to the 1% is the ownership of financial capital. This capital combines with the exploding supply of labor in the developing world to drive up residual profits while driving down world wages. Policies to reverse this by favoring domestic labor unions only hamper national growth in a competitive world economy where capital is highly mobile and seeks out the highest risk-adjusted rate of return. The only solution is to increase the participation of the workforce in risk-taking capital investment and capital accumulation (think entrepreneurship). The present policies of the Obama administration and the Federal Reserve impede this participation and are hollowing out the middle class. If anyone has benefited from these policies, it is the 1% in the financial sector.

The following is reprinted from the WSJ with a link to the original remarks by Krueger.

…four key factors driving the “superstar” economy: technology, scale, luck and an erosion of social norms that compress prices and incomes.

By Sudeep Reddy

The U.S. economy is looking increasingly like the music industry: a small sliver of people are capturing the largest gains.

That’s the view from the White House’s resident expert in the economics of rock and roll, who is wrapping up a tour as chairman of the president’s Council of Economic Advisers.

Alan Krueger, who became a leading scholar in Rockonomics long before his time in the Obama administration, says in a speech Wednesday evening at the Rock and Roll Hall of Fame in Cleveland that the U.S. is “increasingly becoming a ‘winner-take-all’ economy,” following the long experience of the music industry.

“Over recent decades, technological change, globalization and an erosion of the institutions and practices that support shared prosperity in the U.S. have put the middle class under increasing stress,” he says, according to his prepared remarks. “The lucky and the talented — and it is often hard to tell the difference — have been doing better and better, while the vast majority has struggled to keep up.”

In Cleveland speech, titled “Land of Hope and Dreams: Rock and Roll, Economics, and Rebuilding the Middle Class,” Mr. Krueger outlines the key income trends in the music industry across recent decades:

The music industry has undergone a profound shift over the last 30 years. The price of the average concert ticket increased by nearly 400% from 1981 to 2012, much faster than the 150% rise in overall consumer price inflation. And prices for the best seats for the best performers have increased even faster.

At the same time, the share of concert revenue taken home by the top 1% of performers has more than doubled, rising from 26 percent in 1982 to 56 percent in 2003. The top 5 percent take home almost 90 percent of all concert revenues.

This is an extreme version of what has happened to the U.S. income distribution as a whole. The top 1% of families doubled their share of income from 1979 to 2011. In 1979, the top 1% took home 10 percent of national income, and in 2011 they took home 20%. By this measure, incomes in the entire U.S. economy today are almost as skewed as they were in the rock ‘n roll industry when Bruce Springsteen cut “Born in the U.S.A.”

He highlights four key factors driving the “superstar” economy: technology, scale, luck and an erosion of social norms that compress prices and incomes.

On the latter point, Mr. Krueger says: “As inequality has increased in society in general, norms of fairness have been under pressure and have evolved. Prices have risen for the best seats at the hottest shows — and made it possible for the best artists to make over $100 million for one tour — but this has come with a backlash from many fans who feel that rock ‘n roll is straying from its roots. And this is a risk to the entire industry.”

Those four same forces shaping the music industry are also shaping the U.S. economy, Mr. Krueger says. The end result: 84% of the total income growth in the U.S. from 1979 to 2011 went to the top 1% of families. All the income growth from 2000 to 2007 went to the top 1%.

Mr. Krueger runs through the most important research and trends in income inequality in the U.S. over the past century. Read his full remarks here.