Aftershock: The Next Economy and America's Future (3 page)

The borrowing had taken the form of mortgage debt on homes and commercial buildings, consumer installment debt, and foreign debt. Eccles understood that this debt bubble was bound to burst. And when it did, consumer spending would shrink.

And so it did. When there were no more poker chips to be loaned on credit, debtors were forced to curtail their consumption. This naturally reduced the demand for goods of all kinds and brought on higher unemployment. Unemployment further decreased the consumption of goods, which further increased unemployment.

For Eccles, widening inequality was the main culprit.

If Eccles’s insight into the major cause of the Great Depression sounds familiar to you, that’s no coincidence. Although the Depression was far more severe than the Great Recession that officially began in December 2007, the two episodes are closely
related. As Mark Twain once observed, history does not repeat itself, but it sometimes rhymes. Had America not experienced the Great Depression, policymakers eighty years later would not have learned how to use fiscal and monetary policies to contain the immediate economic threat posed by the Great Recession. But we did not learn the
larger
lesson of the 1930s: that when the distribution of income gets too far out of whack, the economy needs to be reorganized so the broad middle class has enough buying power to rejuvenate the economy over the longer term. Until we take this lesson to heart, we will be living with the Great Recession’s aftershock of high unemployment and low wages, and an increasingly angry middle class.

The wages of the typical American hardly increased in the three decades leading up to the Crash of 2008, considering inflation. In the 2000s, they actually dropped. According to the Census Bureau, in 2007
a male worker earning the median male wage (that is, smack in the middle, with as many men earning more than he did as earning less) took home just over $45,000. Considering inflation, this was
less
than the typical male worker earned thirty years before. Middle-class family incomes were only slightly higher.
^*

But the American economy was much larger in 2007 than it was thirty years before. If those gains had been divided equally among Americans, the typical person would be more than 60 percent better off than he actually was by 2007. Where did the gains go? As in the years preceding the Great Depression, a growing share went to the top. It was just like Eccles’s “giant suction pump,” drawing “into a few hands an increasing portion” of the nation’s total earnings.

Economists Emmanuel Saez and Thomas Piketty have examined
tax records extending back to 1913. They discovered an interesting pattern. The share of total income going to the richest 1 percent of Americans peaked in both 1928 and in 2007, at over 23 percent (see
Figure 1
). The same pattern held for the richest one-tenth of 1 percent (representing about thirteen thousand households in 2007): Their share of total income also peaked in 1928 and 2007, at over 11 percent. And the same pattern applies for the richest 10 percent, who in each of these peak years received almost half the total.

Between the two peaks is a long, deep valley. After 1928, the share of national income going to the top 1 percent steadily declined, from more than 23 percent to 16–17 percent in the 1930s, then to 11–15 percent in the 1940s, and to 9–11 percent in the 1950s and 1960s, finally reaching the valley floor of 8–9 percent in the 1970s. After this, the share going to the richest 1 percent began to climb again: 10–14 percent of national income in the 1980s, 15–19 percent in the late 1990s, and over 21 percent in 2005, reaching its next peak of more than 23 percent in 2007. (At this writing, there are no data after 2007.) If you look at the shares going to the top 10 percent, or even the top one-tenth of 1 percent, you’ll see the same long valley in between the two peaks.

In the 1920s, when Marriner Eccles was still a banker in Utah, it looked as if American capitalism was splitting by class.
Sociologists Robert S. Lynd and his wife, Helen Merrell Lynd, after observing life in Muncie, Indiana (then a small city of thirty-five thousand that the Lynds took to be representative of America and which they called “Middletown”), recorded the growing division:

FIGURE 1

Top 1 Percent Share of Total Income

By 2007, America’s “working class” was making fewer “things” and offering more personal services, but the gap between them and the executives at the top had grown as large as it was in the 1920s. Muncie, Indiana, had more than doubled in size, yet the big manufacturers that once provided jobs to Muncie’s working class—Delco Remy, Westinghouse, Indiana Steel and Wire, General Motors, and BorgWarner—had closed in the 1980s and 1990s. By 2007, Muncie’s largest employers were Wal-Mart, Ball Memorial Hospital and Cardinal Health System, Ball State University, Muncie Community Schools, the quasi-government financial corporation Sallie Mae, and the City of Muncie. Meanwhile, Muncie’s (and America’s) old “business class” had become smaller, better educated, and more professional—increasingly centered in the executive suites of large corporations and financial firms. The two groups—working class and business class—once again earned vastly different wages and benefits and had sharply different ways of life.

Across the nation, the most affluent Americans have been seceding from the rest of the nation into their own separate geographical communities with tax bases (or fees) that can underwrite much higher levels of services. They have moved into office parks and gated communities, and relied increasingly on private security guards instead of public police, private spas and clubs rather than public parks and pools, and private schools (or elite public ones in their own upscale communities) for their children rather than the public schools most other children attend. Being rich now means having enough money that you don’t have to
encounter anyone who isn’t. The middle class and the poor, meanwhile, rely on public services whose funding is ever more precarious: schools whose classrooms are more crowded; public parks and libraries open fewer hours and often less attended to; and buses and subways that are more congested. The adjective “public” in public services has often come to mean “inadequate.”

There is another parallel. In the years leading up to 2007, with the real wages of the middle class flat or dropping, the only way they could keep on buying—raising their living standards in proportion to the nation’s growing output—was by going deep into debt. “As in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing,” as Eccles put it.
Savings had averaged 9–10 percent of after-tax income from the 1950s to the early 1980s, but by the mid-2000s were down to just 3 percent. The drop in savings had its mirror image in household debt (including mortgages), which rose from 55 percent of household income in the 1960s to an unsustainable 138 percent by 2007. Ominously, much of this debt was backed by the rising market value of people’s homes.

The years leading up to the Great Depression saw a similar pattern. Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled.
Total mortgage debt was almost three times higher in 1929 than in 1920. Eventually, in 1929, as in 2008, there were “no more poker chips to be loaned on credit,” in Eccles’s words. And “when … credit ran out, the game stopped.”

A third parallel: In both periods, richer Americans used their soaring incomes and access to credit to speculate in a limited range of assets. With so many dollars pursuing the same assets, values exploded.
The Dow Jones Industrial Average reached eight thousand on July 16, 1997, and eleven thousand on May 3, 1999.
More money poured into dot-coms than could be efficiently used, then into more miles of fiber-optic cable than could ever be profitable. The Dow dropped when these bubbles burst but recovered on self-fulfilling expectations of even higher share prices to come—rising to twelve thousand on October 19, 2006, then to thirteen thousand on April 25, 2007. With easy access to credit, the middle class joined in the party, boosting housing prices to all-time highs. Yet it is an iron law of economics, as well as of physics, that expanding bubbles eventually burst.

In the 1920s, richer Americans created stock and real estate bubbles that foreshadowed those of the late 1990s and 2000s. The Dow Jones Stock Index ballooned from 63.9 in mid-1921 to a peak of 381.2 eight years later, before it plunged. There was also frantic speculation in land. The Florida real estate boom lured thousands of investors into the Everglades, from where many never returned, at least financially.

Wall Street cheered them on in the 1920s, making a ton of money off gullible investors, almost exactly as it would in the 2000s. In 1928, Goldman Sachs and Company created the Goldman Sachs Trading Corporation, which promptly went on a speculative binge, luring innocent investors along the way.
Four years later, after the giant bubble burst, Mr. Sachs appeared before the Senate.

Meanwhile, National City Bank, which eventually would become Citigroup, repackaged bad Latin American debt as new securities, which it then sold to investors no less gullible than Goldman Sachs’s. After the Crash, National City’s top executives helped themselves to the bank’s remaining assets as interest-free loans, while their investors and depositors were left with pieces of paper worth a tiny fraction of what they had paid for them.

Yet however much Wall Street’s daredevil antics in the 1920s and in the 2000s were proximate causes of the giant bubbles of these two eras, the bubbles also reflected the deeper problems Eccles identified—the growing imbalance between what most people earned as workers and what they spent as consumers, and the increasingly lopsided share of total income going to the top. In both eras, had the share going to the middle class not fallen, middle-class consumers would not have needed to go as deeply into debt in order to sustain their middle-class lifestyle. Had the rich received a smaller share, they would not have bid up the prices of speculative assets so high.

The biggest difference between the two eras was in what happened
next
, after the bubbles burst. In the wake of the Great Crash of 1929, the economy went into a vicious downward cycle. Unemployed workers, with little or no access to credit, were unable to purchase much of anything. This caused businesses to lay off even more workers, which further contracted spending, leading to even more layoffs. The resulting Great Depression shook America
to its core. The magnitude of that crisis forced the nation to seek ways to overcome both the widening economic divide that had contributed to it and the economic insecurities it fueled. The undeniable reality that almost all Americans shared the ravages of the Depression resulted in an unusual degree of social cohesion, giving the nation the political will to make the needed reforms.

Government policies in the wake of the Great Depression led to a new economic order, including many of the programs Marriner Eccles proposed on the eve of Roosevelt’s inauguration—social insurance, and improvements in the nation’s infrastructure, schools, and public universities. Initially, these were financed by government borrowing. They made the American middle class in subsequent years vastly more secure, prosperous, and productive. As we shall examine in more detail, unemployment insurance, Social Security in old age, disability benefits, and, eventually, Medicare and Medicaid propped up incomes even when misfortune struck. After World War II, a vast expansion of public higher education, interstate highways, and defense-sponsored research and development of sophisticated technologies improved workers’ productivity and wages. And support of their rights to form labor unions, work at a base of forty hours and get time and a half overtime, and receive a minimum wage improved their bargaining power. During the war, government spending reached unprecedented levels. The nation put its full industrial capacity to use, employing almost all working-age Americans. And even though that capacity was largely dedicated to military demands, the sheer volume of production also met civilian needs. By the end of the war, most surviving Americans were better off than they had been at its start, and the Great Depression had irrevocably ended. America’s debt was huge, to be sure, but in subsequent years a buoyant economy enabled government to repay a substantial portion.