Consumers get mixed messages

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Ellen Frank has long been a critic of government policies that favor wealthy Americans over the middle class. Her assessment: The current economic agenda contributes to consumers remaining stuck in an unending cycle of borrowing and spending.

At a glance
Name: Ellen Frank, Ph.D.
Hometown: Brookline, Mass.
Education: Bachelor’s degree and Ph.D. in economics from the University of Massachusetts, Amherst.
Career highlights:
  • Author of “The Raw Deal: How Myths and Misinformation about Deficit, Inflation, and Wealth Impoverish America.”
  • Senior economic analyst at the Poverty Institute in Providence, R.I.
  • Visiting professor of economics at the University of Massachusetts Boston.
  • Taught economics at several colleges, including Emmanuel, Wellesley and Mount Holyoke.
  • Contributing editor to Dollars and Sense: The Magazine of Economic Justice.
  • Staff economist for the Center for Popular Economics in Amherst, Mass.
  • Served on the Council on Monetary and Financial Policy at the Economic Policy Institute in Washington, D.C.

She argues that the financial industry has long had the ear of the federal government when it comes to formulating U.S. economic policy. And debates about that policy have been so confusing that most people don’t understand it.

In her book, “The Raw Deal,” Frank points out several paradoxical messages that plague the American psyche. Among them: Consumers are prodded to spend more to fuel the economy, but at the same time, admonished for not saving enough. Also, cutbacks in consumer borrowing will hurl the economy into recession, yet Americans need more punitive bankruptcy laws to rein in irresponsible borrowing.

Consequently, working-class Americans largely have been marginalized in the debate over U.S. economic policy. Further, wage and income growth for the typical American household has become stagnant or has fallen despite overall economic growth.

Frank proposes increases in federal spending on Social Security, health care and education programs. Her rationale: If consumers had to worry less about retirement, high medical expenses and skyrocketing college tuition, they would have more money to pump into the economy and personal savings accounts.

Bankrate caught up with Frank at her home in the Boston suburb of Brookline, Mass., to talk about some of the larger forces affecting the U.S. economy, myths about Social Security and financial issues facing American consumers.

You’ve argued that the financial industry has had an influence in setting U.S. economic policy and in limiting public discourse about it. Could you provide some examples of this, and how does this affect the average consumer?

The financial industry has influenced macroeconomic policies that are to the advantage and benefit of people whose interest is in preserving financial wealth. The Fed’s primary policy is an anti-inflation policy.

A very good example of this is the current situation right now where we are facing rising oil prices and food prices — including the highest inflation rate we’ve seen in decades. The rising inflation is primarily destructive to people who hold financial wealth and live off past accumulations of money.

The financial industry is harmed by inflation — so are ordinary people whose wages and salaries are losing purchasing power. The idea that we would try to curb inflation through some kind of price-control policy on oil, for example, or some kind of curb on wages and prices to maintain economic growth (in the face of rising prices) is not even discussed. It’s not on the agenda.

Instead, it’s this feeling that if the Fed raises interest rates to try to slow the economy down enough, rising prices aren’t passed through the economy and inflation doesn’t accelerate. This is one of the ways in which the financial industry influences policy — the idea that the Fed has the absolute authority and mandate to control inflation by slowing its growth down and by curbing wage growth is assumed, and that was not the case in the 1960s and 1970s.

Consumers are told that economic growth can’t proceed unless Americans save more; yet they are also told that the world economy depends on American spending. Consumers have also been blamed for their irresponsible borrowing habits, yet they are told that any cutback in consumer borrowing will push the economy into recession. Why are such schizophrenic messages about saving and spending aimed at U.S. consumers? And which of these messages are actually true?

Well, they’re both true. There are schizophrenic messages because there is the paradox of market economies. It’s the structural paradox of the economic system. On one hand, we need sources of spending in order to have economic growth, but on the other hand, we need sources of saving in order to have economic security.

The ways to resolve that paradox involve government spending — which has been off the agenda for a generation. So in the absence of government spending programs that would either serve as the engine of economic spending or serve as the engine of economic security, there’s no other way to resolve the paradox. Consumers on one hand need to spend to promote economic growth, on the other hand, they need to save to promote individual economic security.

For the past generation, there has been political backlash against the government being either the source of economic growth or security. For example, consumers would worry less about economic security if the Social Security system were more stable and better financed and replaced a higher portion of people’s wages. If the health care system were more stable and publicly financed, people would have less concern about bankruptcy or having to save for a major medical problem. … But because the U.S. doesn’t provide these sources of economic security, Americans feel they need to save for these things. On the other hand, if they save for these things, the economy slows down.

So it’s an endless cycle then?

No, it creates a paradox and a schizophrenic and contradictory economic system.

Do you think government input could help ease that?

I think government input is the only way to resolve the paradox.

Let’s talk for a moment about our national debts. There are various estimates as to when Social Security will run out of money. Will it really run dry? How will that affect future retirees?

The (Social Security) trust fund is just an accounting device. Social Security cannot in fact run out of money because Social Security is not ultimately a financial system. It’s ultimately a transfer program that transfers resources, not money, but actual economic resources from working people to nonworking retirees. Therefore, it only functions in the present time. So although we can talk about saving for Social Security and saving for the future, it’s only in the present time that Social Security is actually operating. So although we can establish a trust fund and establish a savings pool, the savings pool is more of an accounting device that states what the future problem is going to be than it is a solution to any future problem.

What do you mean when you say Social Security transfers resources, not money?

You can’t actually save milk, bread and housing and things like that. Things that are going to be needed in the future have to actually be produced in the future. So in 20 years’ time or 30 years’ time or whenever it is that you retire, the question of whether there will be enough money for your retirement is really a question of whether there will be enough resources available. Will the generations who are working be able to produce enough to cover their own needs and cover your needs as a retiree? That can only really be decided 20 or 30 years from now when you retire. So in that sense, Social Security cannot go bankrupt and it’s always going to be politically possible for retirees to have a public pension system. To talk about Social Security going bankrupt and not being available when your generation retires or my generation retires is really just scare tactics as far as I’m concerned.

Do you think Americans would be better off if Social Security funds were diverted into individual investment accounts and invested in the stock market?

I think it is a bad idea. The reason it’s a bad idea is clear from what happened in 2001-2002 when the stock market crashed. We saw that when the stock market crashed, small investors lost a tremendous amount of money. Small investors took a much larger hit, about two-thirds greater, than large investors, because small investors had less information and had much larger fees charged to their accounts.

Small investors do not do as well in the market. They are likely to have poor information, get out later when the market dips and furthermore, the more that small investors go into the market with the intention of taking funds out to live on, the less likely they are to get the kinds of returns that the market has generated in the past.

The reason the market has generated returns that are about double the rate of (the) GDP is because people in the past have not needed to cash these returns in to live on them. If people are going into the stock market with the intention of cashing returns out and having to live on them, then the market is not going to be able to sustain returns better than the growth of the economy — that’s just basic simple arithmetic.

Therefore, I don’t think that a lot of little Social Security retirement accounts are likely to do as well as a lot of financial advisers predict that they will do. Individual retirement accounts are not as good a deal, not as stable a deal, as a public pension system. It’s likely that people are going to become more reliant and not less reliant in the future on a public pension system and we’re going to need to devote more resources, not less resources, to the public pension system.

The U.S. national debt is approaching $10 trillion. Is debt that is privately held more meaningful to the average consumer than debt held by the federal and other government agencies? What should be done about this?

The debt that matters is the debt that’s held outside of the government. Of that, the debt that matters the most is the debt that’s held outside the country. A fair amount of the U.S. national debt is held in China. That debt is probably the most worrisome in the sense that it gives the Chinese government a certain amount of leverage over U.S. economic policy. There’s a fear that the Chinese could dump this debt and try to trade in their U.S. government bonds for some other investment vehicle and that might have an effect on U.S. interest rates. But generally I don’t think the U.S. debt is as big a problem as it is often portrayed to the American people.

Is the U.S. economy more robust when personal savings rates are low? If so, how does that dynamic work and who is the winner in that situation?

It’s not clear to me that the economy is more robust when personal savings rates are low. The U.S. personal savings rate has been failing dramatically over the past generation. One of the reasons for that is income distribution has become so unequal that most Americans can’t afford to save anymore. Over the past generation, wage growth and income growth for the typical household has been stagnant or has fallen despite economic growth. So despite the fact that the economy has grown, most Americans have seen their incomes stagnate or fall, and this has been true since about 1979.

What forces are behind that?

I think the forces behind that are the shift in economic policies that began in the 1980s toward a more deregulated economy — an economy that offers much less protection against market forces for ordinary Americans — you know, supply side economics and what was called “trickle-down economics.” There was a shift to a less progressive tax system and a shredding of the safety net under first Reagan, then Bush. There was a slight reversal on these trends under Clinton and then a shift back toward supply side economics under George W. Bush over the past eight years.

Globalization, the loss of manufacturing jobs and the loss of unions were also part of that equation. It’s a very complicated story, but it’s a story that has seen the ordinary American, the median earner, lose ground pretty much consistently with some slight reversal during the Clinton years. The result of that has been that people have basically stopped saving money and went into debt. Most people have low savings or zero savings or negative savings where they borrow money and spend more than their incomes.

This has made the economy pretty fragile actually, because people are in danger of going into bankruptcy and losing their homes. I think, overall, Americans have engaged in constant spending and they’ve done that based on a very minimal safety net with a very high accumulation of debt.

What is the best way for consumers to borrow wisely, yet prepare for retirement given the economic conditions that we face today?

From the perspective of the individual consumer, one of the things we’ve seen over the last several years is that borrowing against the home is not a great idea. People were really encouraged to take out home equity loans, and the financial industry heavily marketed home equity borrowing. So despite the run up in home prices, consumers now have less equity in their homes than they did a generation ago because of borrowing against equity. The current generation of homeowners is looking at entering retirement still owing money on their mortgages, which is not how people entered retirement a generation ago. So I think borrowing against the home is proving to be an unwise form of borrowing.

People also need to use credit cards much more judiciously. Although all this borrowing and spending is good for the economy, it’s not good for the individual financial net worth. People need to try to spend less and save more. Each of us individually is better off when we do that, even though the economy is better off when we’re all spending like crazy.

Would you describe the modern U.S. economy as “winner-take-all”? If that’s true, how does the middle class benefit, if at all?

That term was borrowed from Robert Frank (no relation), an economist at Cornell who said that a lot of markets had become what he called winner-take-all markets, where most of the income goes to a very small number of people. It doesn’t benefit the middle class. What happens is income flows into very few hands and there’s less leftover for ordinary people.

An example of that was last spring when Forbes magazine reported that the top three hedge fund managers made incomes of about $3 billion apiece. I think it was $3.7 billion, $2.9 billion and $2.8 billion each. When people are collecting incomes of $3 billion, there’s that much less leftover for you and me. That means in the middle classes, you’re going to see income stagnating and that’s why we saw the median income, for example, over the last few years, fall by a thousand dollars. So the middle class is struggling to make ends meet, to pay their mortgages and struggling to heat their homes.

This is not a sustainable situation and so savings rates fall, and we have these discussions about how people can stay out of debt and prepare for their financial futures. In a sense these discussions are useful, and it’s important for people to think about these things, but on the other hand, it’s also important for people to be aware of these bigger systemic forces in which they’re operating.

I think, personally, that people need to expend at least as much energy on the political system and becoming aware of economic policy and pressuring their congressmen and legislators to do something about these forces that are making it difficult to secure their economic futures.