Household Finance

Adrift in a Sea of Red Ink

D. Chorafas

• Publisher: Palgrave Macmillan
• Year: 2015
• ISBN:
  9781137299451
• Topic: Commerce
• Subtopic: Comptabilité

The 'good life' for households has passed. The unwanted result which accompanied it is the sea of red ink. Confidence in the western way of life will not return until the current mess of a dysfunctional society, and its economy, is cleared out. Household Finance explains why and how this can be done.

Part I

Society is Under Stress All Over the Western World

1

Our Society Has to Review its Business Model

1.1 Pericles 2013

In the first year of the Peloponnesian War each side’s successes were few and equally distributed. But a pestilence decimated the population of ancient Athens and the citizens’ morale dropped to a low point – many spoke against Pericles, the city-state’s leader, who was personally responsible for the devastating war. The Athenians condemned him for breaking the peaceful coexistence with the Spartans, and attributed to him the miseries that the hostilities had brought.

To defend himself, Pericles used his skills as an orator, answering back that the citizen of a republic, brought up as a free citizen, must accept the greatest adversity when it comes. They should not lose view of their destiny. (I would advise Greeks, Italians, French, Spanish and Portuguese citizens to take good notice of this dictum.) Forget your personal miseries, Pericles said, in order to have no other thought than the public good. This is the argument Western governments are using today when people complain of:

• Unemployment;

• Austerity measures;

• The difficulty to make ends meet;

• The dismantling of the welfare state which has grown into a state supermarket (see Chapter 4).

The welfare state and its entitlements (see Chapter 2) were intended to be a display of the West’s superior economic power. As President Lyndon Johnson had it, rich countries could afford anything – war and social goodies at the same time.¹ But as entitlements grew they became unaffordable and unsustainable, ending as one more piece of evidence that no social theory lasts forever. Eventually it is undone by its own errors and abuses.

Invented in the twentieth century by William Beveridge, the British public servant, the welfare state has drifted off the rails, and it will remain a failure because its philosophy is that of spending not of producing. Part of the problem lies in a misunderstanding of the notion of “affordability”. Thinking that everything is possible no matter how high its price may be distorts the relationship between means and ends. Political decisions turn on their heads because those making them (from voters to legislators and chiefs of state) have an imperfect appreciation of a modern economy’s opaque forces and twists, and the mix of old political ideas and present day conflicts of interest make small game of analytics provided by macroeconomic models.²

Over the last four decades Western societies have been living in a sort of mirage about their wealth and the power of democracy. Myths led them to spend well beyond their means and the economy’s ability to support the social net. With mountains of debt still rising, Western people and their politicians continue to believe that their country is “rich”, and because it is rich it can afford every folly.

This is the modern version of Pericles’ business model, which eventually destroyed ancient Athens. When the Athenians got into the habit of taking out of the common purse more than they had put in it, their city-state started to decline. Eventually its wealth collapsed, its defences crumbled and its citizens as well as their descendants lived under the yoke of Macedonians, Romans, Byzantines and Turks.

Spending beyond one’s means at sovereign, corporate and house-hold levels is exactly the kind of thing our society does not need – but ironically that’s precisely what it gets. The tragedy of Western nations today is not that they have become poor (though this is the case) but that they think they are rich. It’s an illusion which can best be labelled “Pericles 2013”.

The (wrongly) celebrated father of democracy had come to the conclusion that votes can be bought by distributing entitlement, and that if need be force is right. Getting the money by force from other members of the Athenian alliance ignited the 30-years Peloponnesian War which destroyed ancient Greece. Then as now big spenders of unearned wealth don’t understand that throwing money at the problem leads to policies which are wasteful and inconsistent, and so long as spending goes on unabated, the foundations of government will continue to crumble.

The theory behind this illusion is that the people and their sovereigns can spend, and somebody else will foot the bill. As a model, it mixes candour and a pathetic naivety. “Do not misunderstand me, I am your friend and protector,” Pericles said to the members of the Athenian alliance (read: empire) who were asked to pay for the spend and spend policies of the metropolis. The city-states of the empire, too, initially thought Pericles was their friend; but they did wake up, and the next act was civil war.

There is a moral lesson to be learned from the decay of ancient Athens. Confronted with a growing roster of unsustainable entitlements (see Chapter 2) granted for political reasons by weak governments (without accounting for the consequences), sovereigns sink deeper and deeper into debt. By living beyond their means, the common citizens do likewise; then they fall into despair.

“I … place economy among the first and most important of republican virtues, and public debt as the greatest of the dangers to be feared”, wrote Thomas Jefferson in a letter to William Plumer on 21 July 1816 – but times have changed. The perverse logic of those who today govern the future of Western nations is: bet on debt. What has remained invariant from old times is that somebody has to pay.

Thomas Clausen, a former president of the World Bank and of Bank of America, said that the poorest nations and poorest people will be penalized most. André Tardieu, a former radical, socialist prime minister of France, said that we have to tax the poor, they are the most numerous. This is precisely what is taking place.

To understand the background reasons for déclinisme (decline), the reader should appreciate that a debt-laden society has no claim to wealth. Wealth is the stock of assets one has accumulated minus one’s debts. Because some people are savers and others are big spenders, wealth is shared much less equitably than income. Plenty of people in poor countries have next-to-nothing. But quite a lot of people in rich countries have even less than that, because their liabilities exceed their assets.

Hard work creates wealth when husbanded by business opportunity and a benign environment promoted by a frugal (i.e. careful and economic) government and an economy characterized by the rule of law, good education, low taxes, high savings and plenty of investments. Wealth is not created, indeed it is destroyed, by distributing in small amounts what exists to everybody – like watering the garden.

1.2 The growing gap in wealth and income

From heads of state to common citizens, those who think of themselves as being more intelligent than others tend to ignore the economic realities, on the basis that for decades prior to 2007, though the debt bubble had got bigger, it had not burst. This created a desire to continue with accumulation and the trading of debt, on the belief that there will always be a greater sucker to pass the buck on to. This might work in the short run, but in the longer term it erodes the economy.

Examples are the fate of communism in the Soviet Union and of socialism in France and Sweden. The bottom half of Swedes have a collective net worth of less than zero.³ This, however, does not mean that reckless inequalities and misleading slogans about laissez-faire are the best solution. Without firm regulation, not only the markets but also the whole of Western society bet their future on the “Greater Fool Theory”.

The Great Fool Theory is a dangerous misconception. The French socialists say: “The rich should pay!”. But who are the rich? And are they ready to act as paymasters? Those who have more money also have more sway. The fact that the pyramid of wealth distribution has a very wide base and a sharp point induced Vilfredo Pareto to make Pareto’s Law. Today:

• The richest 1 per cent control 43 per cent of the world’s assets;

• The wealthiest 10 per cent control 83 per cent

• The bottom 50 per cent have only a mere 2 per cent.

In India, a nation of 1.2 billion people, the 100 richest people own assets equivalent to a quarter of gross domestic product. And there are also some US figures worthy of the reader’s attention. There has been a 300 per cent rise in the real incomes of the richest 1 per cent of Americans in the past 30 years, versus a mere 40 per cent rise in the median household income for the same period.⁴

According to the US Congressional Budget Office, between 1979 and 2007, in a little less than three decades, after-tax income grew by 62 per cent for all households, but for the top 1 per cent of earners the growth has been 275 per cent. This top 1 per cent of income earners controlled more than 20 per cent of total national income in 2007, double their share in 1979.

The top 1 per cent and bottom 30 per cent (or even 50 per cent) point to a huge discrepancy in wealth, but also a great disparity in terms of political influence which typically comes hand in glove with control of the world’s capital. Not all politicians are smart, but the majority can read numbers and the numbers tell a lot about the impact of money, which rests on two legs: accumulated wealth and annual income.

According to the US Internal Revenue Service, those in the 1 per cent bracket make $960,000 or more per year – round it to $1 million – in annual income. Not everybody, however, is in accord with this definition. According to The Economist, the average US household income in 2008 was $1.2 million, but the 1 per cent began at $380,000 because the average was skewed by the super-rich. In 2007, the Congressional Budget Office put the cut-off at $347,000. Measured not by income but by net worth, in 2009 the top 1 per cent in the US started at $6.9 million.⁵

By some magic, the richer people also pay less in taxes. The Obamas, the current occupants of the White House, paid 20.5 per cent on their 2011 income of $789,000.⁶ At that level, Barack and Michelle Obama are in the top 1 per cent of US income earners according to both the Congressional Budget Office and The Economist definitions. Mitt Romney, the Republican challenger in the November 2012 elections, also paid 20 per cent in taxes even though his annual income is some $20 million.⁷

“Million” is becoming a rather obsolete unit of income and wealth measurement. “Billion” (one thousand million) is today’s metric. At the end of the twentieth century, near the peak of the dot.com stock market, there were world-wide about 200 billionaires, the largest number in America and in Europe, but also many in Asia. A decade or so later, in 2010, there were nearly one thousand billionaires: over 400 in the US and Canada; 230 in Europe; 120 in Asia (other than China and India); and nearly 200 in the so-called BRICS: Brazil, Russia, India and China – a 500 per cent increase.⁸

These statistics provide an impressive pattern of the concentration of wealth, but one should also account for its high volatility. Vast fortunes have come and gone. Typically, big fortunes took a generation or two to make, but did not last longer than the next two generations. Today large fortunes are made and lost at higher speed thanks to the growing financialization of wealth (see section 1.7) promoted by novel, volatile and risky instruments.

There has been no time in human history when wealth was distributed in an even way in spite of all the “isms” such as socialism, fascism, Nazism and communism. But as long as there were jobs, and therefore income, differences in wealth were not brought under the magnifying glass. “Treasure the things that are difficult to attain,” urges a Chinese motto. In America “riches” were the goal of most young people starting their careers.

Misery, by contrast, is not characterized by volatility. It has the nasty habit of staying around and spreading. In 2010, in America, 46.2 million people fell below the poverty line, calculated as an annual income of $22,300 for a family of four and $11,140 for an individual. This increase lifted the poverty rate to more than 15 per cent of the US population, the highest in 50 years.

The averages also suffered. The median household income which stood at $52,500 in 2000 dropped to below $49,500 in 2010. Such a drop becomes more significant if inflation in the first decade of this century is accounted for. Moreover, the aftermath of the recession has seen to it that the reduction of income is skewed towards the financially weaker members of society.

This is not the only bad news. Given the widely accepted projections that both shorter term and longer term unemployment will continue at high rates, economists do not predict a turnaround in household incomes any time soon. Instead, they expect the current pattern to continue for several years. Analysts underscore the difficulties facing the federal and state governments as they seek at the same time to reduce deficits and help growing numbers of those worse off.

The increase in poverty among the working age population is a new phenomenon in Western countries. The late 2011 data laid bare the damage created by the deep economic and financial crisis which started in 2007 with the banking crisis. Not only were jobs massively lost and the number of unemployed soared, particularly the longer term unemployed, but the collapse in real estate prices in America, Britain and Spain set those countries back by a decade in real estate net wealth.

Wealth and income of course is not the same thing, but they do correlate. Income is more important than wealth, and the latter is created by the former if expenses are kept under lock and key.⁹ The salient problem for the new generation is work and income, rather than inherited wealth.¹⁰ Inherited wealth eventually destro...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Tables
• Acknowledgements
• Introduction: Reasons for a Unified Approach to Economic Theory
• PART I SOCIETY IS UNDER STRESS ALL OVER THE WESTERN WORLD
• PART II HOUSEHOLDS MUST GET THEIR ACT TOGETHER
• Notes
• Index