Politics & Ideas

The U.S. Needs a New Social Contract

We must close the gap between productivity and compensation.

By William A. Galston

Feb. 11, 2014 7:46 p.m. ET

Getty Images/Ikon Images

The biggest economic story of this era is the Great Decoupling of wages and benefits from economic productivity. There has been a massive shift of national output from labor to capital. With it have come stagnating household incomes and a creeping loss of confidence. Translating productivity gains into rising living standards for average families is the country's central economic challenge.

To be sure, a piece of the problem is cyclical. Between 2007 and 2012, household incomes fell for five straight years, to the 1989 level. Despite some improvement in 2013, household incomes today stand 6.4% below where they were at the beginning of the recession and—remarkably4.7% below the level at the end of the recession, according to Sentier Research. A more robust recovery would certainly help.

But the big story goes well beyond even the Great Recession. In the quarter-century after World War II, total compensation—wages and benefits that workers receiverose in tandem with productivity gains

Between 1947 and 1973, output per hour rose at an annual rate of 2.8%, while annual gains in hourly compensation (adjusted for inflation) averaged 2.6%. The fruits of postwar prosperity were widely shared, and public satisfaction with government was high.

Then everything changed. The gap began to widen in the 1970s, and then it soared. Between 1979 and 1990, productivity rose annually by an average of 1.4%, while compensation averaged increases of only 0.5%.

The 1990s were better:
Productivity gains accelerated to 2.1% yearly, and compensation to 1.5%. But because compensation grew at less than three-quarters the rate of productivity, the gap continued to widen.

Since 2000, the picture has dimmed again. Although the pace of annual productivity gains has actually increased to 2.3%, compensation rose by only 0.9%, and the gap widened still more.

Taken individually, these numbers may not seem significant. But their cumulative effect has been dramatic. In 1947, labor received 67% of nonfarm business output. At the end of 1973, that figure still stood at 66%. In 2012 (the latest year for which data have been released), labor received only 58% of total output, the lowest by far in the entire postwar period.

During the past four decades, forces at home and abroad have combined to shift the balance between labor and capital in the United States, a trend that shows no sign of reversing. Increasing the minimum wage might help at the margin. But the problem is much more fundamental, and it extends well beyond our borders.

Since 1990, labor's share of total output has declined in almost every country. In half of them, the decline began in the 1970s and amounts to 10 percentage points or more. The U.S. is anything but an outlier.

Summarizing a large body of research, a 2012 report for the Organization for Economic Cooperation and Development (with 34 member countries) attributes this development to three principal factors: the worsening position of low-education workers, changes in technology, and the globalization of production, competition and capital flows. The OECD was unable to find a strong correlation between the strength of collective bargaining in specific countries and labor's share of their output, and the report suggests that globalization broadly reduced workers' negotiating power, regardless of collective-bargaining arrangements.

When compensation fails to keep pace with productivity, workers' purchasing power becomes less able to sustain economic growth. Since 1990, two trends masked the difficulty: rising household debt relative to income, and growth in overseas markets as developing and former communist-bloc countries entered the global economy. But U.S. household debt reached unsustainable levels by 2007, and the boom in developing countries—especially China, India, Brazil, South Africa and Turkeyappears to have peaked. As both Europe and the U.S. are discovering, the domestic market still matters, and weak gains in household income are bound to retard economic growth.

What can we do? A serious long-term infrastructure program would boost employment and wages as well as economic efficiency. A crash program to reduce our appalling high-school dropout rate while creating high-quality technical training would improve the prospects for workers without college degrees. A renewed commitment to basic research would help create new products and industries down the road.

But the facts push me to a more radical conclusion: We cannot expect robust, sustainable economic growth unless we can figure out how average households can participate in the fruits of that growth, as they did in the postwar period. We need nothing less than a new norm—a revised social contract—that links compensation to productivity. And because we cannot return to the conditions that once sustained that link, we need new policies to bring it about.

Neither political party has come close to proposing anything of the sort, and the American people know it.

viernes, febrero 14, 2014



In my last article I had suggested that gold had found a bottom at $1200 and that there was a likelihood that enormous demand for physical gold from China would drive the price higher this year. On the day it was published (January 28), the price of gold was at $1250 (Comex front-month basis). Eleven days later, gold is 3.6% higher at $1295, with most of that move in the last three days. While I was not expecting the long term bull trend to reassert itself this quickly, China returned last Friday from its week-long observance of the Chinese New Year and has continued buying gold at 2013's record-breaking pace

Moreover, it looks like India may shortly ease its restrictions on gold imports. Both factors combined could easily drive the price of gold up to the $2,000 level that I forecasted in my last article.

In my view based on studying and trading gold on a daily basis, it definitely seems to be behaving a bit differently. The intra-day profit-taking sell-offs are not as steep and the price seems to bounce back more quickly. This 20-yr monthly chart of gold can add some perspective:

(click to enlarge)

I like using a long-term monthly chart in analyzing trends because it "cleanses" out the day to day "noise" and volatility. As you can see, based on the monthly pattern, gold is still in a long term bull trend pattern that started with the $255 low of March 31, 2001. You can see gold has had a couple of corrective sell-offs during this period, each of them roughly the same in percentage amounts as I detailed in the article linked above.

There are what I believe two compelling features on this chart. First the extreme oversold condition of gold as shown by the RSI and MACD (black circles) momentum indicators. At no point in the last 20 years has the gold market been this oversold. The second attribute is the bullish bounce off of the long term trend line of support (black line). Whether or not this ends up being an oversold bounce that turns into another leg is open for debate and remains to be seen. But the fact that the RSI indicator has already turned back up (top black circle) somewhat confirms that the long-term price momentum has shifted back to the upside. My interpretation of the graph above, and which is supported by strong demand fundamentals as I'll detail shortly, is that gold has finished its price correction to the downside and is getting ready to make a big bull move higher.

In terms of the fundamentals, let's take a look at the supply/demand aspect of the physical gold market. As I showed in my previous article, 2100 tonnes ("tonnes" is a metric ton, which is the conventional measure of the global market) of physical gold were delivered into China via the Shanghai Gold Exchange (SGE) in 2013. That's a rate of about 40 tonnes per week. In the first four weeks of 2014, an average of 54 tonnes per week were delivered

Many might have explained this as a buying push ahead of China's week long celebration of the Chinese New Year. However, after being closed last week, the SGE has delivered 59 tonnes of gold in the first three days this week, with 29.5 tonnes delivered last night (Wednesday night). So far based on these numbers - in the context of the amount of gold delivered in January, it would appear as if the rate of gold buying in China could increase this year over last year's record amount. If this is the case, it will put significant upward pressure on the price of gold.

The other side of the China's influence on the demand for gold is the supply. The world produces from mines about 2300 tonnes of gold per year. Although, with several large miners announcing mine closures due to the low price of gold during 2013, it is likely that 2013's production level will be closer to 2100 tonnes - about equal to what was delivered on the SGE. This leaves a supply hole in 2013 for the rest of the world that was largely filled by the 1000+ tonne reduction in gold from the various physical gold ETFs, the Comex and Central Bank gold leasing. The fact that China's demand for physical gold is putting pressure on physical supplies is evidenced by the recent negative GOFO (Gold Forward) rates being observed on the LBMA (London Bullion Marketing Association). I explain what the GOFO is and the significance of negative GOFO rates in this article.

Briefly, when there's a shortage of gold available from the LBMA to be delivered, the bullion banks (LBMA market-making banks) will pay holders of gold bars to borrow the bars. The banks "cover" this borrow by buying gold forwards (similar to futures) for the delivery of gold in the future. That gold is then returned to the holder who had loaned out its gold. The 1-month GOFO rate went negative in early February. Two days ago it went negative out to three months and the negativity of the 1-2 month rates have been steadily increasing. The reason this occurs is because there is increasing demand from the bullion banks to source/borrow gold which can be delivered to buyers. If China's demand for the first 6 weeks of 2014 continues going forward, we can expect to see even higher negative GOFO rates and ultimately a much higher market price of gold. I have always believed that eventually the demand from the physical gold market would begin to drive the price of gold a lot higher and we may be seeing the start of that process.

One last demand factor could have a significant upward influence on the price of gold. As most of you know, the Indian Government slapped import controls on gold imported into India last summer ahead of India's biggest seasonal buying period of the year. This sharply reduced the amount of gold imported into India in 2013, which was on pace for a record year of gold imports. The import controls were designed to curtail India's rapidly increasing current account deficit. Yesterday it was reported that India's trade deficit had declined enough that the trade ministry recommended easing the gold import restrictions. If the Government follows through on this recommendation, it will likely trigger a huge amount of buying

This is especially the case as the spring marks India's second largest seasonal buying period. In other words, if India's pent-up demand is layered onto China's current buying, it could trigger a big move higher in the price of gold, which is what would be required to slow down demand in order to balance out supply and demand.

As outlined above, gold is still in a long-term bull market pattern which is firmly supported by fundamental supply/demand factors. On the assumption that China continues importing gold at the rate it has been importing gold so far this year, I expect that China's demand alone for gold will drive the price higher. If India's gold import volume becomes a factor, I am confident that there's a good chance my $2,000/oz gold target for 2014 will be realized.

You can look through some of my past articles for some ideas on how to take advantage of a big move higher in the price of gold. One factor I will discuss in my next article, and which is a factor that reinforces the bull view of gold, is the recent move being made by the mining shares. While YTD the price of gold is up 6.9%, the Market Vectors Gold Miners ETF (GDX) is up 18.5% and the Market Vectors Junior Gold Miners ETF (GDXJ) is up 30.1%. On the basis that share prices tend to move higher in reflection of an anticipated growth in their underlying source of profit - gold in this case - the mining shares so far are confirming my forecast for a higher price of gold

Several of the junior stocks we own in the fund I manage and am invested in have seen gains this year so far of 50-100%. For me this further confirms that the market is anticipating a much higher price of gold this year.

The ECB’s Bridge Too Far

Ashoka Mody

FEB 11, 2014

Newsart for The ECB’s Bridge Too Far

PRINCETONThe German Constitutional Court’s recent decision to refer the complaint against the European Central Bank’s so-calledoutright monetary transactions” to the European Court of Justice (ECJ) leaves the scheme’s fate uncertain. What is clear is that the economics behind OMT is flawed – and so is the politics.

The OMT program arose in August 2012, when months of relentlessly rising risk premiums on Spanish and Italian sovereign bonds were threatening the eurozone’s survival and endangering the world economy. To restore confidence and buy time for governments to reduce borrowing, ECB President Mario Draghi pledged to dowhatever it takes” to preserve the eurozone – and that meant potentially unlimited purchases of distressed eurozone members’ government bonds.

Draghi’s declaration worked, prompting a sharp decline in risk premiums across the eurozone’s troubled economies. But Bundesbank President Jens Weidmann, a member of the ECB’s Governing Council, immediately challenged OMT, asserting that the program exceeded the ECB’s mandate and violated Article 123 of the Lisbon Treaty, which bars monetary financing of distressed sovereigns. Before OMT was ever activated, Weidmann took his case to the German Constitutional Court.

OMT supporters were aghast at Weidmann’s attempt to overturn the arrangement. After all, the mere announcement of the program had provided relief to struggling governments and may well have saved the monetary union, at least temporarily. Draghi audaciously described OMT as “probably the most successful monetary-policy measure undertaken in recent time.”

But the German Constitutional Court remains dubious. While it has withheld a final judgment in deference to the ECJ, it has upheld the Bundesbank’s view that OMT, in its current form, violates the Lisbon Treaty. OMT may still survive; but, if it does, it will likely be diluted, allowing the problems that inspired it to reemerge.

However problematic this might be for OMT’s supporters, it should not have come as a surprise. The program was ill-conceived and sold by sleight of hand. The court was right to question the factual basis of the ECB’s claim that the risk premiums reflected an unfounded market fear – a claim that was based on cherry-picked evidence. Indeed, the program’s public defense rests shakily on a presumption of baseless speculative pressures.

The program’s design, however, conceded that the market’s assessments of creditworthiness reflected a real default risk. As a lender of last resort to sovereigns, a central bank must stand ready to purchase sovereign debt unconditionally, in order to neutralize the effects of temporary market disruptions. But OMT is intended to operate more like the International Monetary Fund’s lending that is, to rescue a particular government conditional on its pursuit of fiscal belt-tightening. If the ECB were truly convinced that risk premiums were unreasonably high, and that distressed countries’ debt was sustainable, conditionality would have been unnecessary.

Moreover, by tackling default risk, the OMT program created a new problem: private creditors, assured that the ECB would prevent governments from defaulting, were encouraged to lend with greater abandon. Reading the decline in risk premiums as a sign of renewed market confidence in distressed sovereigns’ creditworthiness was another self-serving misinterpretation.

A similar situation has unfolded before. In the pre-euro era, propping up the Italian lira invited unrelenting speculative pressure. With the lira eliminated, holding down yields on sovereign debt can be a fool’s errand.

Just as untenably high exchange rates must ultimately depreciate, default is necessary in cases of unsustainable sovereign debt. This is all the more important in view of the ECB’s disinclination to reverse near-deflationary conditions, which raise the effective debt-repayment burden further.

Sovereign-debt attorneys Lee Buchheit and Mitu Gulati warn that markets could “mercilessly test the ECB’s willingness to persist in buying unlimited quantities of peripheral sovereign bonds.” This test will be all the more severe if, as the ECB has conceded to the German Constitutional Court, the bond purchases would actually be limited.

The eurozone must allow for selective default on sovereign debt, with the ECB acting as a lender of last resort for solvent governments. Of course, solvency can be difficult to assess during a crisis. But pretending that sovereigns are never insolvent serves only to compound the problem. As the German court pointed out, the prospect of default will help to maintain financial-market discipline.

By attempting to create a quick fix for the eurozone’s deep-rooted problems, the ECB has stepped into a political quagmire. Even if the ECJ gives OMT the benefit of the doubt, the program’s legitimacy will remain plagued by qualms, leaving the ECBif only behind the scenes locked in political jockeying with distressed sovereigns.

The line between audacity and hubris is a fine one. Rather than constituting a great success, OMT may well be remembered as an error born of expediency. Worse, it could undermine the ECB’s hard-won independence and credibility. That is an outcome that the eurozone might not survive.

Ashoka Mody is Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs at Princeton University and a visiting fellow at Bruegel, the Brussels-based economic think tank. He is a former mission chief for Germany and Ireland at the International Monetary Fund.