Robert Pozen, Senior Lecturer, MIT Sloan School of Management
Equity investors are euphoric about the Federal Reserve’s expected move to lower interest rates, after its four small increases in 2018. However, rates are still far below normal levels, so this move would create serious problems for government policy and investor choice.
By keeping interest rates so low for so long, the Federal Reserve is losing its best monetary tool for fighting the next recession, and implicitly undermining Congressional efforts to constrain spending and preserve fiscal firepower. During this extended period, the Fed’s suppression of interest rates is also taking a heavy toll on bond investors: They can’t find relatively safe bonds with reasonable yields, so they are reaching for higher yields by buying very risky bonds.
When the U.S. economy falls into the next recession, as it inevitably must, the Federal Reserve needs to respond by sharply lowering interest rates. This is the main monetary tool the Fed has to push the economy back into a growth mode. However, U.S. interest rates are now so low that the Fed has little dry powder in its arsenal. For example, rates on 10-year U.S. Treasury bonds have dropped to 2%, as compared to a 5% average before the last financial crisis in 2008.
Slow wage growth since the Great Recession has been puzzling. As the economic recovery has clocked eight years of growth, unemployment has dropped, but real median wages have barely increased. Commentators have looked for explanations in everything from the rise of artificial intelligence to the scarring effects of the decade-old economic crisis. However, slow US wage growth has a longer history. Relative to the rapid growth marking the post-World War II period, median real wages have grown little since the 1970s (except for the economic boom of the late 1990s).
A growing body of research points to the decline in worker bargaining power as a core explanation. The long membership decline of labor unions has made it harder for workers to demand higher pay. In some local labor markets, increased market concentration has left few employers able to dictate terms to workers. The real federal minimum wage has slipped by around 30 percent from its peak in the late 1960s.
In recent research, I found another, more subtle reason why worker bargaining power has declined. When workers bargain over wages with employers, it is not just their clout vis-a-vis their immediate employer that matters. A combination of rising outsourcing and consolidation of large buyers has left more and more workers employed at companies dependent on a few outside buyers for sales revenue. These large buyers can effectively pressure suppliers to reduce wages: If buyers demand price and cost-cutting, often suppliers pass these pressures along to their workers.
These buyers do not see or meet their suppliers’ workers. This social distance means large buyers can ignore the fairness norms and social pressure that would otherwise raise workers’ pay. For example, when companies outsource janitorial or security workers, these outsourced workers face slower wage growth.
On August 17, President Trump waded into another complex area by a short tweet. He had apparently asked several top business leaders how to “make business (jobs) even better in the United States.” He then directed the Securities and Exchange Commission to study one business leader’s reply: “Stop quarterly reporting and go to a six-month system.”
Trump’s tweet reflects the belief of many corporate executives and commentators that quarterly reporting pushes public companies away from attractive long-term investments. However, the long-term benefits of semi-annual reporting are doubtful, while its costs are significant.
Shifting company reports to every six months does not meet anyone’s definition of the long-term. An extra three months to announce financial results would not induce American executives to take off the shelf the hypothetical stockpile of long-term, job-creating projects — now allegedly stymied by quarterly reporting.
For years, public companies like Amazon have achieved large market capitalizations by following long-term strategies, as investors waited patiently. Indeed, most biotechs go public successfully without any history of profits, so investors must be endorsing their plans for completing clinical trials and marketing their drugs.
What is gold? Is it the essential bedrock of fiscal prudence? Is it a political football, with fortunes and importance determined by far greater forces? Or is it a mere distraction at the margins of the global financial system — attracting a disproportionate number of scams and oddball political characters?
Gold in the American economic system has been all of these and in that order. James Ledbetter weaves a highly readable tale, literally from the origins of the republic to the dubious sponsors of Glenn Beck on Fox News (a brilliant concluding chapter). Too often, this kind of economic history becomes dry and even soporific. But Ledbetter — the editor of Inc. magazine — has a fine eye for personality and ideas; each of the 12 chapters puts you on the spot at a critical moment on the American journey with gold, with anecdotes nicely blended to create the broader historical context.
You can read it in chronological order or you can dip a toe in at any point, almost the ideal summer reading. Or — my favorite for this kind of tale — watch the story unfold backwards; start with the modern and familiar, and see how far you need to go back in time before it feels like you are watching something straight out of Marvel Comics, with big characters and motivations that now seem strange. The most compelling material explains how President Franklin D. Roosevelt reluctantly yet effectively — and with very good reason — ended the way gold had operated over the previous half century. But Operation Goldfinger is also highly entertaining — a 1960s public policy escapade, inspired by the James Bond movie.
The broader plot line is this. The American republic was initially bankrupt, a point that the hit musical Hamilton made more effectively than any middle school history lesson. A monetary system subsequently modeled on that of Britain included gold as an anchor of value for paper money and bank deposits. This system provided sufficient stability in good times — along with plenty of opportunity for financial speculation and shenanigans — and could also be suspended when circumstances dictated, most notably during the Civil War.
What makes the stock market move over the long term? While stocks have historically delivered positive returns year-over-year on average, it is not clear why stock prices rise more rapidly in one period than in any other.
With my colleagues, Martin Lettau of the U.C. Berkeley Haas School of Business and Sydney Ludvigson of New York University, I set out to investigate what makes stocks move over time. What we found was surprising.
Despite the widespread belief that firm productivity is a key driver of stock market returns, our results indicate that fluctuations in productivity play only a small role. Far more influential over long periods is the economic redistribution between workers and shareholders — meaning how a company’s profits are divided between employees and investors.
Our first step in this research was to consider which factors might be responsible for movement in the stock market in aggregate. Each firm that is represented in the stock market index produces a stream of revenues. After paying a portion to workers, the rest is left over as profits that can be distributed to shareholders as dividends. The stock price will rise whenever the rewards to the shareholders increase, which can be caused by one of three separate forces:
Productivity: The firm becomes more productive, increasing its stream of revenues. This increases the size of both slices, including the shareholders’ slice.
Redistribution: The size of the pie remains fixed, but the firm pays a smaller share to the workers, increasing the shareholders’ slice.
Market confidence: Neither the size nor the division of the pie changes, but more risk-tolerant investors demand more stock despite there being no change in their current dividends.