The explanation is quite simple. The Federal Reserve and other American policymakers have to balance between economic growth and inflation. Economic growth is a measure of the number of dollars spent from one year to the next. Inflation is a measure of how many dollars need to be spent to buy everyday goods. These two numbers are tied together--if there are more dollars in the economy, the value of those dollars will naturally decrease and things will become more expensive.
If you have 2% economic growth and 2% inflation, your net gain is 0--the extra dollars in the economy are being used just to keep up with the higher prices. So the goal is to keep the gap between economic growth and inflation as wide as possible.
As a result, for the last several years the government has been acting to slow the economy whenever it appears that inflation might rise. Unfortunately, one of the biggest causes of inflation is an increase in wages--because if ordinary people have more money, they're going to pay more for things and inflation is going to begin. Therefore, whenever wages start to rise much faster than inflation the government acts to slow the economy down.
The result is that working people are never able to benefit from economic growth--since, as soon as the benefits of growth trickle down to the masses in the form of higher wages, the government slows down the tap.
The answer to the problem isn't immediately clear. Economists will tell you that if you allow wages to skyrocket, inflation will go up even faster--and then working people will be poorer in real terms even if the numbers on their paychecks are bigger. If that's true, then some other kind of solution is needed to get the benefits of economic growth to people who are just working. Mutual funds are an attempt to solve this problem; they allow everyone to become owners, and blur the line between workers and owners. A more progressive tax structure would be another useful tool, but that's not something we're likely to see anytime soon.
As a dividing line between creditors and debtors, it is wide as eternity.
The ability to repay a debt is made easier by inflation: more money--I suppose it would be called nominal money--is acquired for not as much work as before the current increase in inflation.
Thus, the value of the debt falls--or at least is easier to pay. This is good for the vast majority of any country's population--but is not so good for those who hold the debts. The value they receive is less than the value of the capital they invested--as measured by the amount of work needed to generate it.
Seen through this lens, the macroeconomic policies of the Fed, controlled by those who control the banks, among the biggest, if not the biggest issuers of credit in the United States, can be understood--and whose actions exert great influence in the entire world.
As for Mutual Funds, they are not any means of blurring the line between workers and owners--Mutual Funds, say the Magellan Fund, is uninterested in what any fundholder wants; it's just another company!
The system doesn't change; it merely becomes more complicated.
A progressive tax structure would be a very good start, but I agree, it is not likely--more likely a regressive tax.
Uncle Greenspan is not trying to keep the worker down... he is trying to grow the whole pie. The fact, that if you have a bigger piece of it now will lead to you getting a larger relative gain then someone who has a smaller piece, is neither here nor there.
Socialist Wolf Between here and there is a revolution, and what would the workers do if your ideas didn't work? I guess they would probably starve.
Inflation occurs predominantly under the following conditions. The workers demand and are granted a raise. Profitability goes down as expenses (wages) rise. The company raises prices for goods. Real money value decreases, and the workers demand more money wages to make up the loss in purchasing power.
The solution to inflation is two fold, the first being the most important, and neither likely to be implemented.
Now you ask what about rising import costs such as oil. Well as prices remain stable, the lack of inflation will increase the demand for that particular nations currency to purchase goods and securities from that nation, and will thus increase the relative value of the national currency in international trade. This will offset the short term increase in cost.
The number one reason that people in the United States are not becoming richer all the time has little to do with inflation, or with some master plan of the rich to oppress the poor, but with the ready and easy ability of consumer credit.
When one considers the real cost of the goods people purchase to live, a consumers spending power has increased dramatically, thanks in part to inflation, but also to modernization, and industrialization. "How can this be so?" you cry. "Prices were much cheaper in the past." you say. But this ignores a very important point. Let's take data from http://www.chipublib.org/004chicago/1900/fam.html, which discusses the cost of living, and living conditions in 1900 Chicago.
According to historical records, the average working man brought home $620.19 a year. In order to earn this, Joe Working Man had to work 60 hours a week. That's 3,120 hours a year spent at work. That means that he earned about $0.20 an hour. Depending on the danger of the work, and amount of labor involved, he might earn more, so, let's give him an hourly wage of $0.25/hr.
In 1900's Chicago, a 1 lb. loaf of bread would cost you $0.05 cents. So it cost Joe Working Man 20 minutes to earn that loaf of bread. Now, a quick check at my local Bi-Lo shows that a loaf of bread can be had for $1.19 a loaf (and is actually on sale for Buy One, Get One Free, but that's neither here nor there). The current (2003) minimum wage is $5.15/hour, but since we let 1900's Joe Working Man have a pay raise, we'll figure 2003 Joe Working Man's had one too, to say $6.00/hour. Not a stellar wage, and I certainly wouldn't want to go back on that wage, but you figure, he's only got to work 12 minutes for that bread. Not an amazing increase, and yes I'm figuring in pre-tax dollars, but stay with me. I could have used the Census figures which state that in 2001, the average income was around $20/hour! That makes that loaf of bread cost a whopping 4 minutes to earn.
So where is all the money going? What's happening? People have turned their increased spending power not to investing and growing wealth, but to purchashing beyond their own means through consumer credit. Want that new TV? Finance it! Lease that fancy Lexus. Get a loan for that new Dell Computer, and so on. Banks are only too willing to lend the money, as long as people request it, and seem able to pay it back. It's not the bank's fault. People make their own choices, and if a person's choice is not to elevate their station in life, but to purchase goods on credit, that's their choice. I've made that choice in my past, and now I'm trying to correct it.
Let's look at the figures: According to the Census, and figures available in a good concise form here (http://www.mbaa.org/present/2003/duncan_0226.pdf) show that since 1960, the debt to income ratio per household has increased to almost 0.95, with the average household debt standing at a staggering $61,500. If the working people of this country have anyone to point the finger at for their inability to be rich, it is themselves, and their spending decisions. And yes, I include myself in that.
It is also an important topic; unfortunately, because of a misunderstanding, ximenez does little to address it. Other contributors do address it, but fail to correct the key misunderstanding:
ximenez says: "If you have 2% economic growth and 2% inflation, your net gain is 0--the extra dollars in the economy are being used just to keep up with the higher prices."
"The people who manage our economy have said quite openly that they will make sure the standard of living for American workers never increases"
The recent passing of stage and film director Elia Kazan4 means that classics such as "On the Waterfront" are all over cable television just now. In the film, corrupt unions extort their members to take out "voluntary" loans, at usurious interest rates, in order to be allowed by the union to work. While Kazan's film is fiction, its at least as accurate as most of the so-called "documentaries" Michael Moore spews out. The scene from On the Waterfront is what is looks like when debt actually prevents the working class from growing rich.
Today, that rarely if ever happens, and certainly doesn't in the case of consumer credit. True, you have to have a credit record in order to do many things in life, but holding a job, buying food, and renting an apartment isn't one of them (many rentals to this day are on a handshake or, legally speaking, "tenant at will" basis, although the lease with credit check, etc. is common with large, corporate housing). Personal bankruptcy laws are generous; if you screw up your credit rating, you can declare bankruptcy and emerge with an unblemished record after a mere seven years; this is a vast improvement over the debtor's prisons of centuries past. Interest rates on credit cards are at times usurious, but only if you mismanage your credit or fail to shop around for a good deal. It's equally inaccurate to say that people are "forced" to smoke cigarettes or buy lotto tickets, and just as accurate to say that smokes and scratch tickets are keeping working people from becoming rich. Unlike cigarettes and the lotto, however, the benefits of easily available consumer credit by far outweigh the problems. The ability of workers to get access to credit and other financial services with minimal fuss is what sets us apart from so many third world economies in which you have to be rich, politically connected, or both in order to access the credit and banking system.
weStLY discusses the relationship between wages and inflation reasonably well; I would just add that this phenomenon is called "cost of living" wage increases. These are inflationary because the wage increases aren't based on the real value of the workers' labor. When these wage increases are passed on to consumers as higher prices, they don't reflect a product with higher value, only a higher nominal price. Therefore, these wage increases are inflationary. That should be contrasted with a wage increase due to e.g. scarce labor. If these wage increases are passed on to the consumer, it means the real value of the product is actually higher than before the wage increase. For example, if there is a shortage of people who are willing to be janitors, the real value of janitorial services is higher, so the increase in the price of hiring a janitor is real, not inflationary.
Socialist Wolf also addresses this point, and proposes mandatory minimum and maximum wages. Presumably, government experts are endowed with a super-human power to a) magically divine what these limits should be and b) resist the incredible temptation to enrich themselves by favoring various special interests (whether business or labor benefits is irrelevant). I'll leave aside the discussion of how this has been tried and failed miserably5, and make another point: here in the US we seem to have stopped inflation without any maximum wage limit, and with a minimum wage that most Socialists consider to be too low. So it seems the Wolf's proposals seem to address a problem (inflation caused by wages that are too high) that doesn't exist.
There is an interesting discussion of the wage-inflation relationship in the public sector at Public sector pay disputes, and at Your Radical Ideas about Capitalism as a Method for Social Control Have Already Occurred to Others.
Footnotes
1. http://www.treas.gov/offices/economic-policy/monitoring_economies.html, Accessed Oct. 12, 2003, 11:32 am. The figures come from the PDF document, which labels them "Real GDP (percent change)" and "Price Indexes (percent change)". This URL could change over time, if it does, try http://www.treas.gov/ and look for the Office of Economic Policy.
2. The Treasury doesn't have much in the way of educational materials on how the GDP and inflation rates are calculated. Perhaps this is because this topic is covered so thoroughly elsewhere on the Internet. For example, http://www.moneychimp.com/glossary/gdp.htm or try http://www.ask.com/ and search on "Gdp Calculation".
3. For a wacky, and a little creepy, treatment of the standard of living, see the Federal Reserve Bank of San Francisco's "Great Economists Treasure Hunt" page at http://www.frbsf.org/education/activities/treasurehunt/index.html. Oh yeah, and the "openly stated" claim that the powers that be actually claim to want to increase our standard of living may be found e.g. at http://www.frbsf.org/publications/education/greateconomists/frames.html.
4. I use Kazan in this example just to brighten up a possibly dry topic. Stretching the tangent to ridiculous lengths is the forte of E2, so: Perhaps someone will reflexively point out that Kazan "named names" in the McCarthy hearings, from which we're supposed to question his entire body of work. Permit me to point out that if Roman Polanski can be forgiven for (statutorily) raping girls, then running from the law, Kazan may be forgiven for naming names, which while morally questionable, isn't even illegal. End tangent.
5. The point about minimum and maximum wages is, who decides, and on what basis. Communism is only the most dramatic example of the madness that happens when "experts" (either the Comintern or FDR's or Nixon's wage and price controls) decide to dictate wages. In my opinion, the people should decide wages by direct democracy. Now, we could subject the price of everything to a ballot vote every year or something, but such a ballot would be more ridiculous than the recent California recall ballot. Besides, why bother with ballots (at public expense!) when in a free market, producers and consumers "vote" with each and every purchase decision they make, and the price of everything is constantly updated to reflect the results! By far, the best form of direct democracy in the world, so far, is the free market.
A Wage Cap is a socialist idea, certainly, but there is no slippery slope toward a Stalinist regime. All of the Communist failed-states (which is to say, all of them) degenerated to dictatorships because they involved war, revolution, social upheaval, and all that rot. At no point were they ever true Communisms.
So here's how a wage cap works: All salaries, stock options, and gifts to any employee (generally an executive) cannot exceed a certain amount per year. Let's say, for argument's sake, that the limit is set at $5 million. For the CEO who makes $8 million per year, let's call him Rex Thane, this is upsetting, but let us also assume (fantasize, more likely) that there's nothing he can do about it but eat it. He can't take 4 1/2 months off each year, becuase then he will be accruing greater expenses without any income. Rex took a $3 million pay cut.
Fortunately, Rex won't miss it. He's making $5 million per year! That is an astronomical sum of money. At that wage, he could work for a few months and retire to a healthy middle-class lifestyle until he dies. What's the difference between $8 million and $5 million? Maybe an extra mansion at Martha's Vinyard or whatever. No one deserves that sort of money. Yes, Rex may be very skilled, or he may have invented something very useful, but it is ludicrous for them to have that much reward.
So what happened to that $3 million? Since the company is now not paying it to Rex, it has several options. It can lower prices, raise wages, hire more people, or reinvest the money. In the first three cases, the standards of living of other people go up at effectively no cost. In the fourth case, the company becomes wealthier and more productive, advancing society. Win-win-win-win.
So where do we set the cap? It doesn't matter too terribly much, since we're dealing with such large amounts. Let's start it at $5 million and adjust annually for inflation.
Any other complaints?
Edit: e-hadj said: "Coupla' points. How come the vast majority of Communists I talked to (prior to e.g. the Sov invasion of Afghanistan) defended Leninism/Stalinism, etc. as stages towards, or the realization of, true communism? Why weren't they protesting the Sov's abuse of the label "Communist"?"
I dunno, man, I wasn't around back them.
"Also, did you read all of my footnote 5? FDR and Nixon's flirtation with socialism / managed free markets (My POV, the two are nearly =, but <> Communism) failed also."
Yeah, but that's an unfair generalization. If *all* socialist policies were unmitigated disasters, as you claim, then we wouldn't have, say, health insurance. Or, heck, a government at all, since the very idea of Government is socialist.
"Next, high wages for upper management aren't nearly as inflationary as for workers. Given sufficient unit sales, labor cost has far more effect on inflation than exec compensation (except in very rare cases were exec comp. is tied to sales, not profit)."
True, raising worker's wages across the board leads to inflation under the current system, because more people are able to purchase the same number of things; when demand increases but supply stays the same, price increases.
However, in the long run, total purchasing power would still improve for the non-Rich because of similar market forces. Since the very wealthy now have less money, the industries that they supported (yacht construction, gold mining, etc) will have reduced sales and have to shrink. Many of the people that they employed will lose their jobs. So where will they go? Why, the economy car market is expanding, since that's what non-rich people buy. The housing market would positively explode. Manufacture of less frivolous goods will increase. The people ousted from the industries that catered to the upper class will find new employment in industries that are demanded by the non-rich.
The Point: While, in the short run, inflation would indeed increase, in the long run it would be canceled out by more production.
"Also, if CEO's pay is limited by government, they will be compensated in other ways (e.g. they will become employees of an offshore management company or otherwise 'outsourced'...) Companies have to compete for a scare resource, good CEOs, just as they do for good workers."
No one ever deserves to make as much money as three hundred other people. That is more than compensation- that's looting.
Enforcement is the only problem with a wage cap. Total compensation, including benefits, gifts, salary, stock options, and 'outsourcing' would all have to count toward the cap for it to be effective.
"Even if Kerry wins, we are 1+ year from enacting these limits, which will probably phase in over 5-10 years (bureaucracy *very* slow, court challenges even slower!). Meanwhile, within months of Enron, the free market had already started taking action. My guess is the free market will arrive at a reasonable consensus on exec comp far sooner than the law. If one doesn't like that consensus, shop for socially responsible goods/services, if even a do so, the market will provide, vs. a majority required to pass the law."
I try to avoid companies that pay excessive executive compensation. However, the average consumer only cares about one thing: Price. The people are not fit to decide policy via the market.
Edit: katanil says: "You should also probably support your claim that all communist system degraded into dictatorships because of war, social upheaval and whatnot. Plenty of capitalistic republics have come about by those means."
Right, to clarify: War, social upheaval, and whatnot are related to Communisms turning into Dictatorships not by causation, but by correlation. Not every country that goes through those things turns into a dictatorship, but every country that is a dictatorship first went through them.
