Hollowing out of middle America

The K-shaped post pandemic recovery has intensified and entrenched the hollowing out of middle America. If not addressed it will become America's undoing.

Low-Income US: Source NPR

For a long time, it has been clear that there is a divergence between the prospects of middle America and those of the wealthy American elites. The recent K-shaped post-pandemic recovery has only intensified this divergence. It is increasingly evident that this divide has been entrenched far too deeply.

Ben Hunt's excellent thesis, titled Hollow Men, Hollow Markets, Hollow World, explains the policies that led to the hollowing out of middle America. It is a must-read piece for those concerned with inequality and political stability. While I agree with Ben, I believe certain aspects need explaining.

Globalisation - Global Wealth v Global GDP

Ben uses this excellent chart to describe the divergence between US wealth and US GDP. He has superimposed the various US Fed chairmen on the corresponding tenures.

I would look at global wealth and global GDP. The rest of the world has created growth by supporting US consumption with lower prices. However, it has hollowed out US job opportunities. The rest of the world, in general, and China, in particular, have deployed unfair practices to hold this state of affairs. The exodus of US manufacturing enterprises and the decline in US jobs have been high, steady and relentless.

This globalisation-driven industrial decline has happened before.

The process of globalisation leading to industries moving to other countries is not new. It happened in 1960-70s when industrial capacity moved to Europe. Then it happened again in 1980s when certain industrial capacities moved to Japan. So the 1990s+ East Asian and Chinese movement is not new.

What is new is that every time before this, there were new growth drivers that either improved the productivity of the US workforce or deployed the US workforce in more lucrative employment or both. This time there are none.

Why are there no new growth drivers?

The Chinese globalisation action was both fast, inorganic i.e. state-sponsored, extremely large in magnitude and unfair. For instance, China set up manufacturing capacities 2X the global demand in certain industries.

It did not give enough time for the US economy to respond organically. Ideally, the transfer of certain industrial capacity to China should have freed US labour and driven them to innovation, creating new growth drivers and thus shouldering the Chinese growth as well.

The US reacted financially. The US deployed monetary and fiscal policies that resulted in a divide between the wealthy and the non-wealthy. The coordinated actions of the US Fed (monetary) and the US Treasury (fiscal) led to a spiral that Ben Hunt highlights in his thesis.

One hidden reason for this policy action.

The US does not have monetary policy independence. This is the corollary of having dollar as the global reserve currency. While the reserve currency status of the dollar was advantageous from WWII till 1970s the burden of being a reserve currency has been evident since Asian Financial crises of 1997/98.

There is no way for the US to devalue the dollar to gain competitiveness in the global trade equations where every currency pegs itself to the US dollar, either a hard peg or soft peg. The result of this pegging is enormous investments made by other sovereigns into US bonds and US financial markets. It reduces the cost of capital within the US but huddles the money among the rich elites.

The way out of this situation is to call the bluff of those pegging their currencies. To call the bluff, the US must take on as much debt as it can while other countries lend to it cheaply.

This strategy is not new either. Former Treasury Secretary John Connally worded it quite colourfully when he said, “It is my view that the foreigners are out to screw us, and it is my job to screw them first”.

But Ben Hunt is right!

No matter the reason, the policies starting from around 1991, have tried to keep rates low, penalising the savers and rewarding those taking on more debt. Corporations and fraudsters have made egregious mistakes in this easy monetary policy era. However, when it was time to make amends, the policymakers assigned losses to savers and middle America while allowing errant corporations to go scot-free.

Post 9/11 and the 2001-03 recession, and more so after the 2008 Global Financial Crisis, things have taken a big downturn. As Ben Hunt puts it, policymakers have transformed emergency government intervention into permanent government policy. It made the rich richer and ignored the poor. The policies are also the result of, again as Ben puts it, the hubris of people like Ben Bernanke and Janet Yellen, who honestly believe that it is not only possible to rescue an economy through monetary policy, but that it is also then possible to control an economy through monetary policy.

As jobs and opportunities dried up, middle America had low-cost debt, home equity lines of credit and other debt-driven mechanisms to magnify their wealth artificially. They also got fentanyl and other drugs to dull their pain. It prevented an early political response from middle America.

The post-pandemic recovery exacerbated this divide. The K-shaped recovery hit the middle and low-income classes hard. Their balance sheets were stretched because of debt build-up, their consumption levels were excessively high, and their incomes were less secure.

Fed tightening and resulting SVB-like crisis will dry up the loans, increase repayments, and reduce incomes, possibly driving the final nail in the coffin while the uber-rich fund ultra-unicorns from their yachts.

It is indeed hollowing out of middle America.

Politicians take heed!

The structural problems in middle America are invisible to the elites, and middle America is shopping around for a political voice. This was the situation that led to Donald Trump beating the elite candidate Hillary Clinton.

However, after the 2020 defeat of Trump, there is no realisation in the elite camp that middle America is indeed facing a structural problem of this magnitude and that political solutions must be voiced to solve this challenge. Even today, I do not see any politician, Republican or Democrat, voicing the concerns of this vote bank.

The elites do see the popularity of Trump. Their way to counteract him is to tie him up at the political funders stage. Political funding comes from elites themselves and therefore is ignorant of the realities of middle America.

In that sense, if Trump manages to get a Republican ticket, he will win.

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