Some sensible writings by Jim Rickards

The Hard Truth About America’s Middle Class

  • Is the middle class getting smaller, or does “middle class” not mean what it once meant?…
  • “If there’s a rising tide lifting boats, whether you have a boat or not, the tide is not rising very quickly”…
  • Then Jim Rickards shows you why so much of today’s wealth is flowing to “parasites” who suck wealth from the economy while adding nothing…

Portsmouth, New Hampshire
October 8, 2018

Jim RickardsDear Reader,

Today I want to step back from my normal market analysis and discuss a problem we hear about all the time now — the idea that the middle class is shrinking.

We know who the rich are. They seem to be getting richer, aided by the stock market artificially rigged in their favor. And we have plenty of poor, whether recent immigrants or minorities or people in depressed areas.

But it seems to many that the middle class is disappearing in front of our eyes.

Is it true?

The answer is a bit more complicated than it first seems. In a nutshell, I would say the middle class isn’t necessarily shrinking. It’s more the case that the middle class doesn’t feel middle class anymore.

Let me explain that distinction.

The middle-class numbers are not necessarily getting smaller. The problem is that middle class doesn’t mean what it used to mean.

Going back 20, 40 or even 60 years to the 1950s during the Eisenhower administration, middle class meant something.

It meant security. It didn’t mean you were rich. It didn’t mean that you drove around in a new Mercedes, but you probably had a new Chevrolet or a new Ford.

It meant you had a steady job, with maybe a pension and good public schools for your children. You could afford to take your family out to dinner every now and then. Not five nights a week, but maybe one night a week or a couple nights a month.

You had neighbors. You had organizations, charities, church, etc. It was a stable existence.

Nobody was going to pull the rug out from under you, and you expected that your children would do even better than you. They would have greater job prospects, they would make more money. That was part of the American dream.

But today’s middle class, the group in the middle 40–60% of earners, does not have any of the things I just described.

You might have a nice house. You might have a job. Maybe your kids have their eye on a better college than you went to, maybe not. But you don’t have the job security. You’re not certain the company you work for will necessarily be around in a couple years.

Even if the company is around, you don’t feel your job is secure. You can be laid off at any time. Workers, including middle-class earners, are being replaced by robots. The opioid crisis is a growing problem, not just among 20-somethings, but also among 40-year-olds and 60-year-olds.

My point is that we still have a middle class and it’s not shrinking. But the definition of middle class has changed. It’s gone from being a much more secure niche in the American economy with an optimistic view of the future to a very insecure niche with a more pessimistic view of the future.

There are reasons for that, and you don’t have to go back very far to find them.

Go back 20 years. That’s not a lifetime. But in 1998, global markets came to the absolute edge of collapse. People don’t realize how close they came to total collapse with the Russia Long Term Capital Management crisis.

In 2000, we had the dot-com collapse. In 2007, the mortgage market collapsed. In 2008, the Lehman Bros. and AIG global financial crisis, and then a very long, slow recovery.

A lot of people think we’re still in recession, and there’s a good reason for that. I would argue that we’re in a depression, not a recession. A depression just means long-term, below-trend growth, with a large wealth gap between where we’re actually growing and our potential for growth.

We’re not realizing our potential, in other words. But technically this expansion that we’re in started in June 2009.

But this has been the slowest, weakest expansion in American history. It’s the second longest in U.S. history, but also the weakest. Many people don’t feel the effects.

If there’s a rising tide lifting boats, whether you have a boat or not, the tide is not rising very quickly. It’s not that there is no middle class. It’s that the middle class doesn’t feel middle class.

They don’t feel that they’re anchored to the American dream. They don’t feel that their prospects are necessarily better, that prospects for their children are necessarily better or that they have security.

All of this is very damaging to growth prospects. It limits spending and investment, which are major headwinds for the U.S. economy.

Below, I show you how parasitic elites are getting richer without adding any real value to the economy. Who’s the poster child for this phenomenon? Read on.

Professional economists, whether with Wall Street, the Federal Reserve, the IMF or academia, all suffer from what I call the tyranny of averages.

They take a group of data and twist it to determine an average. But the problem with averages is that they hide as much as they reveal.

There are roughly 320 million people in the United States. But when you try to create a meaningful average from that number, you’re inviting problems. Averaging out the population misses the fact that there are a small number of rich people at one end and a much larger group of poor people in the other.

Just a way to illustrate the problem, consider one of the old jokes in economics. You have 20 people in a bar and Bill Gates walks in. Suddenly on average, everybody in the bar is a billionaire.

That’s actually a true statement because Bill Gates is worth much more than 21 billion dollars. So if he walks in the bar of 20 people and you average out their net worth, on average, everyone is a billionaire. This is a case where the Harvard statistician would say, on average, everyone is a billionaire. It is a true statement, but completely meaningless.

Needless to say, not everybody in the bar is actually is a billionaire. You have one mega-billionaire and 20 everyday people.

So, when you see averages, average wages, average retail sales, average net worth, average household net worth, take it with a grain of salt. The average can be completely misleading.

There is actually a scientific way of measuring income inequality.

When you’re trying to understand income inequality, the main statistic that economists use is called the Gini coefficient. It’s named after an Italian statistician named Corrado Gini. He published a paper in 1912 as a way to calculate inequality.

The Gini coefficient goes far beyond simple averages. It eliminates the “skew.”

The Gini coefficient is measured on a range between zero and one. A Gini coefficient of zero means perfect equality. It means everybody makes exactly the same amount of money or has exactly the same net worth. In a society where one person owned all the wealth, like a king or a dictator, you would have a Gini coefficient of 1.0.

So the larger the Gini coefficient, the greater the income inequality. Neither extreme happens in the real world. You never have perfect equality, which is 0, and you never have complete inequality, which is 1.0.

So a Gini coefficient is always expressed in decimals, somewhere in between. It can be .12 or .25 or .47 or .79, for example. As long as it’s not extreme, it’s more associated with the middle class.

In truth, Gini coefficients never get to one and not even .80 or .90. The reason is that even the poorest people need the basics to live. Imagine a society where the Gini coefficient was one or maybe .99. That society would last for about three days because everyone else would starve to death.

That society can’t exist, but with a Gini coefficient of .70 or .80, you’re getting closer to that limit.

What’s a normal Gini coefficient or reasonably healthy Gini coefficient?

A Gini coefficient of 0.35 is actually pretty good. That’s what you might find in a place like Sweden, where the degree of income distribution is not extremely skewed towards the rich.

That’s when you have a real middle class. That’s when people are more optimistic. They feel that they have a stake in the game.

When the Gini coefficient rises above .45, when it reaches .50 or higher, or .60 or .70, we’re talking about more extreme inequality.

This is actually more of a problem for rich societies than poor societies because there’s more to steal. The poorest people or the middle class can have a decent lifestyle. But there’s plenty left over for the elites to steal for themselves.

Think more like the United States or Germany or China, for example. There is enough to go around, and therefore, but the system allows a very small group to secure for itself a very disproportionate part of the wealth.

What’s the most recent Gini coefficient for the U.S.?About .41, approaching the level where income inequality becomes more pronounced.

Now, just before I just used the word “steal” to describe the dynamic of the super-rich capturing more and more of societal wealth. Let’s unpack that a bit.

There are actually two kinds of super rich people. I’m talking about Bill Gates or Mark Zuckerberg or Jeff Bezos or Jamie Dimon, CEO of JPMorgan Chase.

There are actually two kinds of these uber rich. There are those who earned it, and those who skimmed it.

Take Bill Gates. He has a net worth around $95 billion, give or take. He’s not only in the 1/10th of the top 1%, he’s in the top 1/100th of 1% of rich people.

But most Americans don’t really begrudge Bill Gates his wealth because he earned it. He built Microsoft. He added value. He sold the software. He was brilliant at marketing. The bottom line is, like him or not, Bill Gates earned his money. He’s super wealthy but he added value to the American economy. He was a net contributor to society.

You can say the same for Jeff Bezos and some others. Again, Americans don’t really resent their wealth because they contributed more than they took and everyone was better off as a result of it.

But let’s take another case, like Jamie Dimon. Jamie Dimon is a billionaire. What does he do for a living? Well, he’s the CEO of a big bank, perhaps the most powerful bank in the world. Now, he should be expected to make a good living.

But a billionaire? For running a bank?

First of all, most of JPMorgan’s liabilities are guaranteed by the United States government in the form of FDIC insurance. Even liabilities not specifically guaranteed day to day can be guaranteed in emergencies, as they were in 2008 during the height of the crisis.

That is, JPMorgan had a 100% guarantee of basically all the liabilities on their balance sheet. Beyond that, JP Morgan’s too big to fail. The U.S. government is not going to let it go down.

Of course JP Morgan’s not alone. There was Goldman Sachs and Morgan Stanley and Citibank and Bank of America.

I don’t mean to pick on Jamie Dimon individually, but he’s a good case of someone profiting far beyond his just deserts. What he takes from the economy greatly exceeds what he adds. So much of his wealth creation is guaranteed by the government.

He’s more of a parasite; someone who takes wealth out of the system without contributing to it, without doing anything particularly innovative.

The problem with the Jamie Dimons of the world is that they are sucking the system dry. Eventually they can kill the economy. Today we have more and more Jamie Dimon types who are siphoning wealth while adding no real value.

That’s bad for growth and that contributes to the high Gini coefficient, which is only going higher.

So what can an investor do to make sure you don’t fall behind?

You can do two things. One, if you want to make more than the next guy as an investor, focus first on your education. Invest in your own education and your children’s education.

Number two, diversify your portfolio. Most people don’t understand diversification. They think if they own stocks in 50 different companies in 10 different sectors, they’re diversified. They’re not. They’re all stocks. They tend to move up and down together.

You get diversification by putting 20% of your portfolio in stocks, 20% in cash, 10% in gold, 10% in land. That’s diversification, because those asset classes are not highly correlated.

As Warren Buffett said, “The key to making money is not losing it.”


Jim Rickards
for The Daily Reckoning

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