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In 1991, the United States officially switched from the gross national to the gross domestic product as the standard measure of output. They’ve basically moved together as this graph from FRED shows:

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However, this obscures something pretty important. Take a look at this simple graph I made, with the GNP as a percent of GDP (left) and debt (right):

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Ok a few very important caveats. The y-axis here is a very narrow range, so the dynamics aren’t nearly as significant as would first seem. But there does seem to be a general trend: that is over the postwar period there was a consistent increase until the ’80s, after which there was a (relatively) sharp decline until 2000, after which GNP/GDP goes up again to its highest point ever.

Note that 2000 was about the year George Bush started to randomly handout tax cuts and weird Medicare provisions. He also decided to invade Iraq. Naturally, our debt load increased. Here’s what Wikipedia says should happen, lest debt be evil:

Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.

Or basically what conservatives have been preaching this whole time. After all, a Treasury is a claim on future American growth. James Hamilton frequently claims that interest rates are going to rise bringing rise to this truth.

Remember: GNP = GDP + American income on foreign assets – foreign income on domestic assets

As the increase in the blue line since 2000 tells us, that last component has been going down well before Bernanke started QE. Brad DeLong talks about a shortage of safe-assets. He’s right. Bernanke has talked about a global savings glut. He’s right.

Whatever the case, despite massively increased public debt, our national income has increased faster than domestic product. Contrary to everything the pols tell you, our claim on the expected future returns of everybody else is more than theirs is on ours, and it keeps growing. Here’s another secret: this means we can and should borrow a lot more money to invest. In fact, America could become something like an ultra bank for a while based only on international confidence in the Dollar.

Of course, the public deficit isn’t the only component in the picture. Foreign companies obviously own American stock and corporate bonds. I hear rich Chinese people are buying land in New York City nowadays. But the point is the biggest fears vis-a-vis short term government debt are, for lack of a better term and irony, inflated.

Here are a few titles befitting of this post:

  • China does not own America
  • The Wall Street Journal is wrong
  • It’s the Dollar-standard, stupid!
  • Wait, we run a trade deficit?
  • America is the biggest and baddest hedge fund of them all.

Look, based on that last point, there’s actually a bit of inbuilt short-term volatility here. Theoretically, we could sell our foreign assets and buy our own very safe debt. Our income comes from American capital equity abroad. Trade theory tells us we’re leveraging ourselves and, obviously (see: 2007), this isn’t always a good thing. 

But we have good reason to believe that much of the world is undergoing relatively strong (I mean in India 5% is bad) economic growth. I’m not saying they’re all in the same convergence club, but over the next 50 years global income is going to increase. Lots. And equity markets are pretty well correlated with GDP in the long-run. (They’re not nearly as much in the short-run, which is where the volatility comes from).

This means as globalization progresses, we might see some short term flux in GNP/GDP, but in the long-run it’s a safe bet.

None of this is defending bad spending (see: the American military). None of this is saying long run problems with regard to social security are no big deal. I am saying that if America was a company, I wouldn’t be all too worried about its finances. That it’s a government with sovereignty over the global reserve currency and oil purchases just makes me a million times more confident.

Noah Smith has an article in The Atlantic about wealth inequality in the United States. A viral video caught the attention of the economics-blogosphere, and Noah is the latest to comment.  The import of Noah’s argument is the importance of thrift:

Today, wealth equality is closely tied to income equality. But in the long run, it’s all about thrift, frugality, and saving — in other words, teaching a consumer nation a lesson in cheapness.

Progressives have a hard time ascribing wealth inequality to savings rate and (predictably, though not incorrectly) blame structural issues like falling wage share of income. As one very popular commentator notes:

This is absurd. The real wealth gap is based in capital gains, not direct income. Teaching Americans to be frugal is not going to address any of the systemic differences that make it easier by orders of magnitude for the already rich to keep making money.

The fact is, poor American’s can save, they just have really bad habits. For example, as Derek Thompson notes, the poor spend a whopping 9% of their income on lottery tickets. So let’s be honest here, the whole diatribe against Noah that the poor can’t save is crap.

If we’re going to talk about wealth inequality, it’s pretty informative to understand its emergence, why it’s fundamentally different from income inequality, and why an “equal” society won’t help. Consider, an island which is functionally equal – you might say socialist. I’m not suggesting this is a plausibly sustainable situation, but it’s an interesting starting point. Let’s also assume that somehow socialism hasn’t eroded work ethic and desire to innovate. In reality, this isn’t a reasonable assumption, but I’m not making an argument about economic ideology.

So, on day one, the Keynesian economist, farmer, laborer, and lawyer each earn $100 a year. The economist is a spendthrift, with a good taste for Portuguese wine and Victorian clothes, and has only $10 left each year. The laborer, saves diligently, and has $50 leftover. Very soon, an island that once had income equality becomes very unequal, both in income and wealth. The wealth inequality comes first, but soon the laborer has more money to invest in his daughter’s education, and to loan to the moderately-thrifty lawyer and farmer to earn a good return.

So wealth inequality comes first. This is especially true if you consider, in our society, income derived from education to be a capital gain (though, legally, it is treated as labor). In the island, wealth and income inequality were both functions of preference.

However, in our society, as wealth inequality isn’t just a function of preferences, but income itself (in the island this isn’t the case because future income inequality is derived from wealth inequality which itself is derived from preferences). But, in a given snapshot, wealth inequality grows as, in some ways, the integral, roughly speaking, of income inequality.

This is because, if preferences are randomly distributed, the savings become a function of income. As income inequality rises (as it has in the past 40 years), the ability to save gets rather more concentrated amongst the rich. This, and not preferences, becomes the key force of wealth inequality. This is further compounded by the fact that, in a very literal sense, wealth begets wealth through capital income.

So my point of all this is I think Noah’s wrong that somehow altering preferences will fix the situation. Noah argues that, for a “return to equality”, the poor need to be nudged and educated:

In addition to “nudging” middle-class and poor Americans to save more, we can help them get a better return on their assets — the second thing that has a huge effect on wealth in the long run. This means helping middle-class people invest in stocks without paying high fees. The first part of this is teaching middle-class people to avoid making frequent changes in their stock portfolios. Studies show that individual investors consistently lose money when they try to buy and sell and buy and sell, mostly because they tend to ignore trading costs. So financial education should teach people to let their stock portfolios just sit there for decades, and ignore the ups and downs.

The second way to get better returns is to avoid actively managed funds. Actively managed mutual funds charge high fees to purchase portfolios of stocks that, statistically, are no better than simply buying a low-cost “index” fund that tracks the overall level of the market. Pension plans like TIAA-CREF tend to charge even higher fees, meaning even worse returns. Financial education can teach middle-class people what a low-cost index fund is, and how to invest in one.

The first point is rather interesting, and Richard Thaler has the best evidence that it might work (Save More Tomorrow – fantastic study, I think everyone should read it). I don’t have much to say about personal finance education, I think it’s important, but I just don’t think it will have a lasting effect on habits in a consumer culture. Education will be artificial and instituted in the context of grades, which will be the only reason people pursue the subject.

But, as I argued, changing preferences will have only an ephemeral effect. What we need are:

  • Robust risk sharing programs (particularly universal healthcare, strong social insurance, and unemployment insurance). This will a) decrease the need for wealth, mitigating the effect of wealth inequality and b) allow the poor to invest most of their income in stocks, so that they can take part in America’s wonderful capital market. Noah mentions China a country that’s poor but manages to save a lot. One of the many reasons for this, I believe, is an underdeveloped insurance market, creating a greater need for wealth.
  • Ban lotteries. This is simple. Sure, states make a lot of money from them, but this is absolutely the most regressive tax in the country. Not only are educated people informed enough to know that the state has an edge, but it’s a very small part of their income.
  • “Nudge” Americans to save through opt-out programs sponsored by an employer.
  • Institute a progressive consumption tax with negative income
  • Fix income inequality.

The integral-relation with income inequality explains why it will always grow as income inequality is constant, but wealth distribution doesn’t need to be as skewed as it is. Preferences will go some way, but the real change needs to come from income distribution (by investing in human capital) and access to capital markets (by pooling risk).

The falling role of labor in our economy will make wealth very important. Acting now is a pretty good idea. But, moving on, let’s remember a few things: demand creates supply, and wealth inequality creates income inequality. Let’s not mistake cause and symptom.