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Power Shift
January 9, 2007 (Stephen S. Roach - Morgan Stanley)
Do not underestimate the significance of the political shift that has just taken place in the US Congress. Not only have the Democrats taken back control of both houses of the US legislature for the first time since 1993, but this is also the first instance in over half a century when they have recaptured both the Senate and the House of Representatives simultaneously. The potential impacts on the economy and financial markets should not be minimized.
This shift in political power is occurring at a unique juncture in the US economic cycle. The profits share of national income currently stands at a 50-year high of 12.4% (see accompanying figure). At the same time, the portion going to labor compensation is just 56.3% -- the lowest a newly elected Congress has faced since 1965. In other words, the Democrats are assuming power at a point in time when the returns to capital are at historical highs and the rewards to labor are at more than 40-year lows. This underscores the most profound economic implication of all: Just as the pendulum of political power has swung to the left in the United States, I think there is a very good chance that the pendulum of economic power could swing from capital back to labor in the years ahead.
AntiSpin: Since 1998, we've been warning The Boyz that running the game too hard in one direction risks an ugly political backlash. Well, here we are, and the question is, just how ugly does it get?
A Wall Street investment banker from one of the major firms told me in the late 1990s during the equity bubble when I was Managing Director of Osborn Capital, "Stock is for assholes. The name of the game on Wall Street is, Who gets the cash?" That may have been over-the-top of the cynicism scale, but the truth is that name of the game on Wall Street is and has always been to first get the money and risk by the sale of new financial products, then push the risk onto someone else–without them or the regulators understanding that that's what you're doing–and keep the money and pocket the fees.
For example, the move by corporations since the late 1980s from offering defined benefit plans–managed by professional money managers–to 401(k) plans–managed by employees–was intended to shift risk off of corporations that used to hold the liability for the performance of defined pension plans off the corporations onto the employees, most of whom have no training to make informed choices among the new financial products that Wall Street invented to take advantage of the 401(k) trend. While many corporations made sincere efforts to help their employees make informed choices among financial products they made available–and I'm for individual responsibility and decision making–which party do you suppose derived the greatest benefit from this risk shifting via the selection of financial products offered to employees and the choices made by employees in aggregate: the employees, the corporations offering 401(k) plans, or Wall Street?
According to the most definitive report on the subject, By Alicia H. Munnell, Mauricio Soto, Jerilyn Libby, and John Prinzivalli or the Center for Retirement Research at Boston College (CRR) "INVESTMENT RETURNS: DEFINED BENEFIT VS. 401(k) PLANS (PDF)" concludes:
p.s. Just came across an interesting book on this subject that came out October 2006: America's Financial Apocalypse: How to Profit from the Next Great Depression
Book Description
"For nearly three decades, America has been gradually losing ground to the developed world in many critical areas. The result is that the American standard of living has been in decline for over two decades, with the middle class having been affected the most. Meanwhile, the rich have gotten wealthier and now America is a nation controlled by corporate America. Hidden by two-income households and open access to credit, declining living standards have gone unnoticed by most Americans. Spending beyond one's means has become the American way of life and is encouraged by the government. In contrast, saving is almost unheard of in America. As a result, this once powerful nation has changed from the world's largest creditor to the world's largest debtor. Decades of over-consumption by Americans can only last so long before a day of reckoning occurs. The deflation of the Internet Bubble resulted in the paper loss of over $7 trillion dollars, yet most people seem to have already forgotten the most scandalous charades in U.S. history by Wall Street and corporate America. And now, as the retirement assets of tens of millions of Americans are in question, an even larger number are caught up in the largest real estate bubble in our history. As we enter the two next decades, 76 million baby boomers will retire, most of them in poverty. Thus, the generation that was responsible for creating the greatest bull market in U.S. history may, through no choice of its own, also be the same group that causes an economic meltdown due to decades of government mismanagement, inadequate planning, and over-consumption."
January 9, 2007 (Stephen S. Roach - Morgan Stanley)
Do not underestimate the significance of the political shift that has just taken place in the US Congress. Not only have the Democrats taken back control of both houses of the US legislature for the first time since 1993, but this is also the first instance in over half a century when they have recaptured both the Senate and the House of Representatives simultaneously. The potential impacts on the economy and financial markets should not be minimized.
This shift in political power is occurring at a unique juncture in the US economic cycle. The profits share of national income currently stands at a 50-year high of 12.4% (see accompanying figure). At the same time, the portion going to labor compensation is just 56.3% -- the lowest a newly elected Congress has faced since 1965. In other words, the Democrats are assuming power at a point in time when the returns to capital are at historical highs and the rewards to labor are at more than 40-year lows. This underscores the most profound economic implication of all: Just as the pendulum of political power has swung to the left in the United States, I think there is a very good chance that the pendulum of economic power could swing from capital back to labor in the years ahead.
AntiSpin: Since 1998, we've been warning The Boyz that running the game too hard in one direction risks an ugly political backlash. Well, here we are, and the question is, just how ugly does it get?
A Wall Street investment banker from one of the major firms told me in the late 1990s during the equity bubble when I was Managing Director of Osborn Capital, "Stock is for assholes. The name of the game on Wall Street is, Who gets the cash?" That may have been over-the-top of the cynicism scale, but the truth is that name of the game on Wall Street is and has always been to first get the money and risk by the sale of new financial products, then push the risk onto someone else–without them or the regulators understanding that that's what you're doing–and keep the money and pocket the fees.
For example, the move by corporations since the late 1980s from offering defined benefit plans–managed by professional money managers–to 401(k) plans–managed by employees–was intended to shift risk off of corporations that used to hold the liability for the performance of defined pension plans off the corporations onto the employees, most of whom have no training to make informed choices among the new financial products that Wall Street invented to take advantage of the 401(k) trend. While many corporations made sincere efforts to help their employees make informed choices among financial products they made available–and I'm for individual responsibility and decision making–which party do you suppose derived the greatest benefit from this risk shifting via the selection of financial products offered to employees and the choices made by employees in aggregate: the employees, the corporations offering 401(k) plans, or Wall Street?
According to the most definitive report on the subject, By Alicia H. Munnell, Mauricio Soto, Jerilyn Libby, and John Prinzivalli or the Center for Retirement Research at Boston College (CRR) "INVESTMENT RETURNS: DEFINED BENEFIT VS. 401(k) PLANS (PDF)" concludes:
The bottom line is that over the period 1988-2004 defined benefit plans outperformed 401(k) plans by one percentage point. This outcome occurred despite the fact that 401(k) plans held a higher portion of their assets in equities during the bull market of the 1990s. Part of the explanation may rest with higher fees, which are deducted before returns are reported to participants. But the one percentage point shortfall understates the investment problem in 401(k) plans, since an aggregate number does not reflect the fact that more than half of participants in 401(k) plans do not follow the prudent investment strategy of diversifying their holdings. Finally, the available data suggest that IRAs produce even lower returns than 401(k) plans, which, if true, implies trouble ahead given the massive amount of money that is being rolled over into these accounts.
If we get the kind of recession over the next two years that I expect, which creates a significant number of insolvent middle class households, political focus on the Wall Street game and backlash against it could get severe. A truly populist President, elected by the Lou Dobbs crowd, could push painful legislation. Many of the reforms we are likely to see are needed, but many will be as unconstructive and politically motivated as Sarbanes-Oxley. Attempts to address the root of the problem, the dressing up of risk shifting and wealth concentrating wolfs in free-market sheep clothing, especially opaque risk shifting products that employ financial engineering schemes developed by the Geeks on behalf of the Jocks (see Jocks and Geeks Theory of Financial System Dysfunction), may wind up producing unexpected and undesirable results. We'll explore this theme this year as the recession unfolds and the 2008 election approaches.p.s. Just came across an interesting book on this subject that came out October 2006: America's Financial Apocalypse: How to Profit from the Next Great Depression
Book Description
"For nearly three decades, America has been gradually losing ground to the developed world in many critical areas. The result is that the American standard of living has been in decline for over two decades, with the middle class having been affected the most. Meanwhile, the rich have gotten wealthier and now America is a nation controlled by corporate America. Hidden by two-income households and open access to credit, declining living standards have gone unnoticed by most Americans. Spending beyond one's means has become the American way of life and is encouraged by the government. In contrast, saving is almost unheard of in America. As a result, this once powerful nation has changed from the world's largest creditor to the world's largest debtor. Decades of over-consumption by Americans can only last so long before a day of reckoning occurs. The deflation of the Internet Bubble resulted in the paper loss of over $7 trillion dollars, yet most people seem to have already forgotten the most scandalous charades in U.S. history by Wall Street and corporate America. And now, as the retirement assets of tens of millions of Americans are in question, an even larger number are caught up in the largest real estate bubble in our history. As we enter the two next decades, 76 million baby boomers will retire, most of them in poverty. Thus, the generation that was responsible for creating the greatest bull market in U.S. history may, through no choice of its own, also be the same group that causes an economic meltdown due to decades of government mismanagement, inadequate planning, and over-consumption."
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