Outside the Box

The Crisis of the Middle Class and American Power

January 11, 2013

Thinking about the long term is all too rare a talent these days and one I really appreciate. When you take a longer view, it is easier to see how all the moving parts, the bits and pieces, fit together. And you can see other streams of action impacting your original line of thought.

In today’s Outside the Box, my (and our) old friend George Friedman thinks about the future of employment and how it impacts the expression of American social order and geopolitical power. Sitting here in Stockholm tonight, that was the very point we were making in our dinner conversation with the management team of the Skagen funds. It is not just a US problem, although George looks at the US. This is a global issue as the gulf between the middle class and the upper income classes is widening, and it is widening for structural reasons. There are no easy answers. Dennis Gartman quotes PJ O’Rourke, who basically launched a shot from the right. It speaks for itself:

 Mr. President, the worst thing that you’ve done is that you sent a message to America in your reelection campaign that we live in a zero-sum universe.

There is a fixed amount of good things. Life is a pizza. If some people have too many slices, other people have to eat the pizza box. You had no answer to Mitt Romney’s argument for more pizza parlors baking more pizzas. The solution to our problems, you said, is redistribution of the pizzas we’ve got—with low-cost, government-subsidized pepperoni somehow materializing as the result of higher taxes on pizza-parlor owners.

In this zero-sum universe there is only so much happiness. The idea is that if we wipe the smile off the faces of people with prosperous businesses and successful careers, that will make the rest of us grin.

There is only so much money. The people who have money are hogging it. The way for the rest of us to get money is to turn the hogs into bacon. The evil of zero-sum thinking and redistributive politics has nothing to do with which things are taken or to whom those things are given or what the sum of zero things is supposed to be. The evil lies in denying people the right, the means, and, indeed, the duty to make more things.

 But George notes the other side (bold emphasis mine):

 Last week I wrote about the crisis of unemployment in Europe. I received a great deal of feedback, with Europeans agreeing that this is the core problem and Americans arguing that the United States has the same problem, asserting that U.S. unemployment is twice as high as the government's official unemployment rate. My counterargument is that unemployment in the United States is not a problem in the same sense that it is in Europe because it does not pose a geopolitical threat. The United States does not face political disintegration from unemployment, whatever the number is. Europe might.

At the same time, I would agree that the United States faces a potentially significant but longer-term geopolitical problem deriving from economic trends. The threat to the United States is the persistent decline in the middle class' standard of living, a problem that is reshaping the social order that has been in place since World War II and that, if it continues, poses a threat to American power.

These issues and the threat they pose have to be resolved. The structural mechanisms are creating the inbalance. We need to nurture creativity and we need to reward it, but it creates a wide dispersion of income.

I think you will find George’s analysis quite thought-provoking, and you may find yourself wanting a Stratfor subscription. They are offering my readers a discount on their excellent products, and, you can get on board by clicking here: https://www.stratfor.com/subscribe/mauldin-jmf.

I am in Stockholm tonight (and did Copenhagen and Oslo) on my way to the south of Spain for a few days, for what is hoped will be a vacation, then a day in London for a Soc-Gen Conference and one of my famous “dinners with interesting people.” Dylan Grice (Soc Gen), Anatole Kaletsky (GaveKal, Simon Hunt (serious expert on copper and China), Dan Stetler (chief econ and Boston Consulting and wicked brilliant), Jonathan Tepper (of Variant Perception and my co-author). Just found out Richard Howard of Hayman Partners (Kyle’s Bass’s operation) and a few others will be there, too. I shall learn a lot. Then I’m off to Greece for five days with Christian Menegatti of Roubini Economics before ending up in Geneva and then returning to Dallas.

Have a great week. I am having a blast and will write your Thoughts from the Frontline letter tomorrow. Three computer crashes in five days! What are the chances? Ugh. But Life is fun and you take it all in stride. Just means I needed to think more about this next letter – maybe I will get it right.

Your ready for some Costa del Sol analyst,

John Mauldin, Editor
Outside the Box

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The Crisis of the Middle Class and American Power

By George Friedman

Founder and Chief Executive Officer

Last week I wrote about the crisis of unemployment in Europe. I received a great deal of feedback, with Europeans agreeing that this is the core problem and Americans arguing that the United States has the same problem, asserting that U.S. unemployment is twice as high as the government's official unemployment rate. My counterargument…

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Paul Dorio

Jan. 13, 2013, 7:07 a.m.

George wrote: “The expectation of rising real incomes was built into the American culture, and many assumed based on that that the rise would resume in five years. When it didn’t they were trapped, but given history, they were not making an irresponsible assumption.”

I disagree that the “assumption” was not “irresponsible.” I was not raised to project my future finances onto my present when making a purchase. Actuarial tables are fine for insurance brokers but not for the average individual attempting to calculate the affordability of a present purchase. The main problem in the USA, from the point of view of the consumer, is the seeming inability to budget accurately.

As they say: Hope is not a strategy. Purchasing a home, or any other large ticket item, without rational and realistic budgeting using one’s current income is absolutely naive, irresponsible and foolhardy.


Jan. 13, 2013, 5:40 a.m.

This is not a crisis of the middle class. This is a systemic crisis of the existing system of production, the crisis of transition to a new system of production. It is only natural that this is beginning to change the value and function of the middle class. This is part of a global change that will change the geopolitical coordinate system change understanding of the economic and political power. Changing the philosophy of the world order ( http://crisismir.com/analiticheskie-materialy/ekonomika/13-mirovoj-ekonomicheskij-krizis-prichiny-i-posledstviya-quo-vadis.html ).In the first stage of the world crisis is over globalization and make way for the construction of the new economy. And the next phase will begin large-scale formation of a new economic system.

Joseph Somerville

Jan. 13, 2013, 12:07 a.m.


Thie was a teriffic analysi, but there is only one answer and until we move or return to it, nothing we say will be more than words raging against the darkness, ‘all sound and fury’...resulting in nothing. Care to know the answer. It is simple, elegant and difficult, but not impossible. If so, email works fine.


Michael J Menzie

Jan. 12, 2013, 11:41 p.m.

Our “global dominance” is a large part of the problem, all the money wasted on our empire would be much better spent on repairing our infrastructure, not to mention the enemies we wouldn’t make by sticking our nose into their business.


Jan. 12, 2013, 11:34 p.m.

Mr. Friedman, you have provided a rationale for what I have been sensing for a few years now, as I witness the underlying seismic shifts in the socio-economic fundamentals of our world.  As a retired Superintendent of Schools for a large urban and suburban school board, it was not hard to see - if you cared to look - that the fundamental basis of our North American world was changing.  I wish your thoughts were required reading for every politician, educator, student and professional in this country, as well as every member of the media.  To go one step further, it should be on the agenda and in the minutes of every board meeting.

Thank you.

Dallas Kennedy

Jan. 12, 2013, 10:26 p.m.

Yes, you have to use per-capita real income, not per-household. But even in those terms, the US middle class has seen its real income decline slightly. And that doesn’t account for explosion in costs for certain middle class goods, in particular, health care and college. These have been inflating faster than the general price level for over 30 years, especially in the last 15 years.

The seeds of these developments were planted in the 1960s and 70s, when an era political overpromising led to money printing and high inflation. The departure of the US from the gold standard in 1971 enabled this development. Better monetary policy in the 80s and early 90s held these trends in check for a while, so that savers could enjoy decent real returns on their savings. But that all changed in the 90s, when the Fed and others decided that the crisis of America living beyond its means could be hidden by financial bubbles. These bubbles enriched financial sector middlemen and some others; it left the aspiring lower middle class and working class—and increasingly, the middle class itself—crushed by debt.

These bubbles also featured a gross misallocation of capital that could have been put to productive use, but was instead put into residential housing (strangely enough, counted as “investment” by the geniuses who run government agencies).

Underlying the housing, higher education, and health care bubbles are large government subsidies that drive up the costs for everyone. Health care and higher ed have been moving in the wrong direction cost-wise for years and are in desperate need of reform. And not everyone needs to own a house. The subprime mortgage bubble that started in the 90s began as an attempt to help lower income homeowners cash in on home equity, all to keep that illusion going of getting wealthier and wealthier.

The basis of the income inequality trend (which is happening in other developed countries—it just started earlier here) is the division between the college-educated and the non-college-educated. Add to that the automation of semi-skilled and unskilled labor, the breakdown of the nuclear family, globalization, and the lack of training alternatives for the non-college-bound (something we used to have), and you have the complete picture of sub-middle-class decline to add to the picture of middle class decline from weak income growth and cost inflation.


Jan. 12, 2013, 2:54 p.m.

Comparing the buying power of median household incomes across several decades is misleading unless and until one adjusts the data for the concomitent changes in average size of households.
The average family today consists of about 2.6 people vs. 3.3 people in the 1950s and 1960s. While the definitions of “households” and “families” may not be completely congruent, one can infer that a household today has to house, cloth, feed, entertain and maintain the health of roughly 25% fewer people than 50+ years ago.
So in that respect, households are quite better off today than in the “good old days.”


Jan. 12, 2013, 2:44 p.m.

I have been travelling in the developing world since the 1970’s.When I began, third-world nations had primitive transport and communications infrastructures and employed hardly any capital equipment - the difference between us and them was enormous. Building a road involved teeming hordes of men breaking rocks and carting them off by hand, and not the giant road-building machines you would see at home. Today, by contrast and in just about every developing nation, the kind of capital equipment we have take for granted is deployed everywhere and in every industry.

As Adam Smith identified, it is comparative advantage that generates wealth, and if you travel the world now you have to ask yourself, where is the US’ comparative advantage? Most developing nations have banking, communications, transport and technologies that are at least as good as our own, and in many cases because newer, better. The rule of law and of property rights is nearly universal, and stock exchanges and sophisticated capital markets trade world-wide. You can trade stocks in Hanoi with as much security and speed as you can in New York, in Beijing as in London. To anyone who remembers the Vietnam and China of the 1970’s, this is simply incredible.

So why should the West be rich and the East be poor?  A hundred years GK Chesterton said the reason the West ruled was that we had the Gatling Gun and they didn’t. Well, now they got the 21st century equivalent of Gatling guns, technology, education and capital, often in improved versions of our own.

Eventually the creation of wealth world-wide will raise all living standards above what the American middle-class has been enjoying, but until it does the effect of leveling across the East and the West will be very painful for us.

Daniel Kennedy 94695649

Jan. 12, 2013, 1:28 p.m.

Technology is clearly reducing the need for and value of labor. However, it is also enabling significantly lower costs of production and, as a result, end product cost. It is also enabling massive customization as products can be produced in economical lots of one. Reducing the need for labor (or increasing the opportunity for leisure) and enabling customization should not be a curse. The issue to be addressed is how does an economy function when the value of labor goes to zip?

Bob Shapiro

Jan. 12, 2013, 12:27 p.m.

I would say that George’s strength is geopolitics, not economics.

Some businesses grow, while others go out of business. Those who go out of business do so mainly because a more efficient competitor has replaced them. By the very nature of competition, existing businesses as a whole are more efficient than those of 100, 50, or even 20 years ago.

George’s proposition that in the ‘80s businesses all of a sudden generally became inefficient because costs rose is insupportable, unless you consider the source of those rising costs. Those costs are taxation, regulation, and crowding out of businesses by government debt issuance from the capital markets today reaching over $1 Trillion a year and $16+ Trillion in total.

George seems to miss the very nature of every business. There are three natural constituencies which must be satisfied. The owners/investors MUST receive a satisfactory reward or they will cease to invest or liquidate. Customers MUST be satisfied or they will not buy what is produced. And, employees MUST receive satisfactory wages & benefits or they will work fewer hours or take a job with a competitive business. If any of the three gets more than a satisfactory share, the other two get less, and the business will become less competitive.

Through high taxes, regulation, and capital market activity, government has insinuated itself as a third constituency which MUST be satisfied, and government decides what is satisfactory for them. Automatically, the other three MUST suffer.

George looks to the education & mortgage benefits of the GI Bill and the construction of the Interstate Highway System as economic game changers for the US. However, while we always can see positive effects of any action (yes, even government action may have some positive effects), we never can see what would have happened in their absence. While George would fall for one of the three great lies (I’m from the Government, and I’m here to help you), I prefer not to be that naive.

The decline of the US Economy, and the decline of the American Middle Class, is the result of too much government. My preferred solution is to reject George’s call for more of “the hair of the dog that bit me.” If too much government is the problem, then less government is the solution.

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