At the very end, I’ll come full circle to explain the connection with productivity, wages, and stock markets valuations.
Federal reserve has three tools for influencing money supply:
- Setting interest rates
- Open market operations (Issuing treasury bonds)
- Setting reserve requirements
- By lowering interest rates it’s cheaper to borrow money and less lucrative to save
- By issuing/buying back treasuring bonds on the open market they effectively inject money into the economy. The Federal Reserve doesn’t have the money: they create money by adding to their balance sheet. They buy the bonds to increase money supply, or issue bonds to shrink money supply.
- Increasing/decreasing reserve requirements impacts what percentage of the banks holdings it can reinvest, which has a money multiplier effect in the economy.
It’s important to make the implications of this as simplistic as possible. As Confucius said: Life is really simple, but we insist on making it complicated.
The Federal Reserve has a few goals, but most important is to stimulate economic growth.
To do this, it uses monetary policy to manipulate liquidity (access to capital) as a driving force in investment and therefore economic growth.
So it makes money more or less expensive to borrow.
Borrowed money that’s being invested doesn’t guarantee it’s being invested in valuable assets.
Two of the biggest areas where money gets invested is:
- Money Lending (banking)
- Stock market
- Banks lend money to people who don’t have it. Student debt. Credit card debt. Home debt. Car debt. Personal debt has skyrocketed.
- The stock market is seen as an indicator of a healthy economy. It is not. If you have cheap money, the collective investors buying stocks on the open market will drive up stock prices well beyond their true value. But if the stock gains outpace the cost to borrow or invest other places, it’ll continue to be the focus institutional investors.
10% of the US population own 85% of the stock market value.
This is in spite of employers moving from company pension funds to 401k.
The stock market overvaluation essentially resets every 10-15 years with a market wake up and contraction in liquidity, resulting in anyone operating unprofitably [ie over leveraged] going broke or bankrupt, causing a recession as well as a massive wealth distribution from anyone barely getting by to those with more than enough.
The bankers and lenders know and see it coming and get out early. Everyone else panics and gets out late with all their gains erased.
Why do we need a credit card to survive? Why is everyone is debt?
Apart of the federal reserves goals for economic growth is:
- Ensure full employment
- Control inflation
When the federal reserve buys bonds it increases the inflation rate. And vice versa.
According to the Philips curve, when inflation is high, unemployment is low, and vice versa (Philips 1958).
When unemployment is high, there is a surplus of labor.
When there is a surplus of labor, wage bargaining power is low. As in, if there are a lot of people lined up for a job, they can’t negotiate their wage. Beggars can’t be choosers.
When there is a shortage of labor, workers can negotiate higher wages: labor has wage barraging power.
The federal reserve prevents full employment, however, by maintaining a target inflation rate of 2%.
The baked in assumption is that full employment is bad, because this will lead to runaway inflation.
However, the Philips curve only describes this relationship in the short term. In the long term, there is zero relationship between employment and inflation, because employment is strongly tied to social factors like education, innovation, and frictional, cyclical, and structural unemployment due to various market demands.
The federal reserve actively manipulates money supply to ensure that there is 3.5-4.5% unemployment rate.
The lower the unemployment rate, the more wage bargaining power.
The higher the unemployment rate, the less wage bargaining power.
The more wage bargaining power, the more workers get paid, the more they spend, the more economic output.
By preventing full employment, the Fed ensures business owners (wealthy) have all bargaining power, and keep all surplus profits.
This results in a labor force that is barely surviving on a living wage.
The result is that consumers save less, and rely on credit/ debt to maintain a more and more expensive lifestyle, or keeping up with the Jones’s.
The reality is that there are plenty of case studies and countries that have less than 1% unemployment, where workers have excellent wages due to wage bargaining power, and there is no runaway inflation. Japan and Germany being the two notable examples. China not far behind.
1. How does productivity increase but wages do not? (Wage stagnation)
When productivity increases and wages do not, there is a simple explanation:
Workers do not have wage bargaining power.
i.e. they are being exploited, producing far more value (profits) than they are being paid for.
2. Where does all this profit go?
The “property owners” (companies, assets, stocks, land) purchase more and more assets with this surplus income. Notably, they invest in the stock market. All these excess profits drive up stock market prices, even though stock prices do not reflect actual value.
But where else do they put their money? Surely they don’t pay laborers what they’re worth. But if laborers aren’t being paid a living wage, how can they spend and consume and generate economic activity and growth? Debt. The wealthy owners lend money back to the laborers. This perpetuates the cycle of enslavement.
Of course, this is a historical phenomenon. The relationship between the capitalists and laborers— the haves and have-nots, master and slave, bourgeoisie and proletariat— is easy to observe throughout history, but always seems impossible to notice as it’s happening.
The inevitable consequence of this inequality manifesting in its extreme is social unrest and overall societal degradation.
When the population speaks up about deteriorating conditions, the “ruling class” (capitalists or property owners and politicians or gatekeepers) employ a timeless strategy: Blame the “other”.
This “other” is any minority group other than the ruling class. This includes minorities, immigrants, foreign countries, climate, and other scape goats. This phenomenon repeats itself throughout history in the most predictable way.
Political leaders, chosen by the ownership class, convince the working populous that the source of their problems is not at home with their leaders, but because of those who have different values and beliefs, who look and act different. The source of all society’s ills are those who are “different”.
This inevitably leads to racism, xenophobia, endless wars, harsh immigration policy, loss of human rights, and persecution of anyone not in line with the self-righteous national identity being promoted.
What do you think?