Saturday, October 19, 2013

Could inequality have caused the Washington standoff?

There has been a lot of discussion on the blogosphere about growing inequality in the United States and its possible negative effects. See examples from FT Alphaville, the IMF paper on inequality and monetary policy, Josh Brown wondering if inequality is responsible for why the American economy can't recover and Washington's Blog,.

The Tea Party's world view
One unintended consequence might have resulted in the recent Washington confrontation over the government shutdown and debt ceiling. This isn't some socialist rant, so stay with me on this.

Brett LoGiurato of Business Insider recently wrote about a trip he made to the district of Rep. Ted Yoho (R-Fla.), a prominent Tea Party leader in the debt ceiling fight. It was unfortunate that the tone of the article was "look at the local yahoos that I found in the land of debt ceiling deniers". Nevertheless, the article had some interesting insights. The district is relatively homogeneous and therefore serves as an echo chamber for Yoho's world views:
As Jeremiah Tattersall exasperatedly puts it, Yoho is living in an echo chamber with people just like him. That's what happens when you win a district drawn in such a way that you win 65% of the vote.

"You answer to birthers. You answer to people who seriously believe you're like Martin Luther King Jr. and Rosa Parks and would be standing next to them," said Tattersall, a field staff of the North Central Florida Central Labor Council, a group that opposes Yoho and often demonstrates against him.

"And you answer to people who don't believe the debt ceiling is a real thing."

Tattersall is right. If you walk up to 20 people at random at various points in this district, there's a good chance that at least 15 will appreciate the fight in which Yoho is participating on their behalf in Washington. The economists' warnings, the temporary Wall Street freak outs — nothing has tempered their willingness to engage in this battle.
I generally don't characterize anyone as a local yahoo, because people have a right to their views. However, it seems that the views of Yoho's constituents are not corroborated by the mathematical realities of the US federal budget:
Why aren't you concerned about defaulting?
"The people who are saying that are using scare tactics," said Todd Newtown, the clerk of the Circuit Court in Trenton.

It's almost a unanimous consensus among economists.
"Well, sure, the Ivy League liberals ..."

There are more than a few Republicans and conservatives who agree that breaching the debt ceiling and risking default would be dangerous, no?
"I think they've bought into the scare tactics."

"Sure, brainwashed."
Asked about what they would cut out of the federal budget, the Yoho constituents' consensus was foreign aid and arts funding. Such comments are typical of the sentiment that I have heard from Tea Party supporters.

Notwithstanding the fact that the foreign aid budget is a drop in the bucket of the federal budget, much of what is termed "foreign aid" can be properly classified as part of the military budget for the United States. Wikipedia shows that in the 2011 US foreign aid budget was roughly $50 billion (out of a total of $3.5 trillion in spending). Most of the foreign aid budget went to the following five countries (in order of magnitude): Afghanistan, Israel, Iraq, Pakistan and Egypt, most of which is military aid for American weapon systems that benefit US manufacturers. As well, aid to most of those countries are for US national security purposes. For example, aid to Afghanistan, Iraq and Pakistan are in support of US military operations in the region and aid cutoff could severely hamper operations in that theatre.

Similarly, arts funding represents roundoff error in the federal budget and their complete elimination does little to affect the level of the deficit.

As well, one of the solutions to hitting the debt ceiling was the prioritization of payments. This way, it was thought, Tea Party supporters could achieve their ideological goal of smaller government. The Bipartisan Budget Policy Center recently laid out some sample choices on what was needed to close the budget gap in the case of payment prioritization.

While the points raised in these slides are moot in light of the latest political developments, they nevertheless illustrates the difficult choices that need to be made. Have Tea Party supporters actually gone through the realities of the budget and done the math?

Could math and financial literacy be the problem?
Then it came to me, it's not that Tea Partiers are stupid, it's just the broad American population doesn't score well on math and financial literacy compared to other major industrialized countries, as per this USA Today report. (Here is a sample version of the test.) Maybe they are just not math and financially literate!
A first-ever international comparison of the labor force in 23 industrialized nations shows that Americans ages 16 to 65 fall below international averages in basic problem-solving, reading and math skills, with gaps between the more- and less-educated in the USA larger than those of many other countries.

The findings, out Tuesday from the U.S. Department of Education, could add new urgency to U.S. schools' efforts to help students compete globally.

The new test was given to about 5,000 Americans between August 2011 and April 2012. The results show that the typical American's literacy score falls below the international average, with adults in 12 countries scoring higher and only five (Poland, Ireland, France, Spain and Italy) scoring lower. In math, 18 countries scored higher, with only two (Italy and Spain) scoring lower. In both cases, several countries' scores were statistically even with the USA.
To bolster my point, a recent FINRA study found that way over-estimated their own financial knowledge but scored badly on the basics of finance.

How could that be? The US higher education system remains the envy of the world. The United States gets the lion's share of Nobel Prizes and parents from all over the world strive to send their children to schools like Harvard and Stanford.

While the quality of the top schools are still unquestioned, the problem is that society and the education system is becoming increasingly bifurcated. Rebecca Strauss of the Renewing America initiative at the Council on Foreign Relations documented this problem [emphasis added]:
Averages can be misleading. The familiar, one-dimensional story told about American education is that it was once the best system in the world but that now it’s headed down the drain, with piles of money thrown down after it.

The truth is that there are two very different education stories in America. The children of the wealthiest 10 percent or so do receive some of the best education in the world, and the quality keeps getting better. For most everyone else, this is not the case. America’s average standing in global education rankings has tumbled not because everyone is falling, but because of the country’s deep, still-widening achievement gap between socioeconomic groups.

And while America does spend plenty on education, it funnels a disproportionate share into educating wealthier students, worsening that gap. The majority of other advanced countries do things differently, at least at the K-12 level, tilting resources in favor of poorer students.

A Darwinian education system
The bifucation is becoming increasingly acute given the reality that not everyone can go to a top school like Princeton or Yale, where earnings prospects are considerably higher. In effect, the elitism that exists in the higher education system is creating inequality and a two-tiered economy (see my previous post Another American step to Argentina). A recent Hamilton Project study showed how income levels affect education. The education system is becoming Darwinian even for the very young. As the chart above from Strauss and the chart below shows, wealthier families can afford to invest more in their children and the results show it.

High achievers get into the best schools. While the stated admission policy of a school like Harvard is "needs blind", most people don't get into Harvard without enrichment when they are young, which costs money. The chart below shows the level of college admission by income quintile (bottom = green, top = purple).

Consider the student loan problem as an illustration of the divide in higher education. While a college degree is still valuable than a high school education, the net value of a degree is falling and the debt incurred to obtain that degree is becoming more of a problem for the average Joe (via Business Insider):

The student loan delinquency problem is particularly acute in the Red States where Tea Party support is the strongest:

It seems that one of the unintended side-effects of the growing inequality is the lack of financial and mathematical literacy. When combined with the Tea Party's populist anger of being isolated and left behind, it resulted in a misguided willingness to take the country over a financial cliff over the issue of the debt ceiling and possible default.

Unfortunately, this situation isn't likely to get any better. Gerard Minack of Morgan Stanley showed that inequality, as measured by the Gini coefficient, is highly correlated with political polarization (via Business Insider):

It seems that we may have to put up with greater polarization and political volatility in the United States. It's no wonder that the US debt rating is getting increasing scrutiny from the rating agencies.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.


NK said...

What is amazing and should be researched is how sociopathic quasi-"educated" elites are rooting for more debt despite obvious proofs that it can't have any other outcome but a total disaster.
Perhaps it is because disaster will strike the poor and not the plundering elites.

Anonymous said...

Excellent post!

Quite a bit outside normal investment fare, but it raises some very important points!

Small point - you might want to check the grammar because in a couple places it is tough to understand. But overall I really, really liked it!

Anonymous said...

letting the facts speak for themselves. beautifully written and presented.

Anonymous said...

I think the main thing the TEA party cares about is taxes. My guess is that most of the TEA party critics don't know what "TEA" stands for.

However, the "literacy" part comes in here. I just don't know if they (TEA party) really understand that their "sacred" entitlements: Social Security and Medicare, are the "biggest part of the problem".

When that realization occurs, then we'll make some progress. It will take a "real" crisis, however. That probably doesn't happen until 2015-2020. It'll be caused by a loss of confidence by some stakeholder;maybe foreign bondholders.

Thanks for your blog.

ryanmburke19 said...

I think it is fair to point out irrationality and financial ignorance of the Tea Party. But then how should we regard the so-called mainstream, who believe that we can run enormous deficits indefinitely and that entitlements need not be addressed. People who want to balance the budget are considered "fringe." And how come those who merely want to see $85bn a month of QE reduced are considered hawks? And if you actually believe that short rates should be raised to a meager 2% 5 years after a crisis, well then you are a lunatic.

While I do not agree too much with the Tea Party, I am equally flabbergasted by the financial ignorance of most of the economics profession as well as the "mainstream" politicians, who believe in magic rather than math.

Cam Hui said...

For an relatively apolitical perspective on the current economic situation and QE, see this video by Ray Dalio of Bridgewater Associates on the credit cycle:

I find Dalio's framework a more useful perspective on what's going on. Sometimes incrementalism works better than sudden austerity. Look what happened in the eurozone.