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Board of Scholars

Education Standards and Culture

Last quarter I wrote about the deficiencies in America’s educational system and how Common Core reform (as it is known) is supposed to improve educational outcomes through a systematic approach to K-12 and even K-16 education.  Common Core means a set of national standards (as opposed to local or state standards) and an emphasis on a common core of classes aimed at crucial areas for testing success.  Will the effort to institute a common core improve American competences in the areas of math, science and reading?

Let me start by dispelling a myth about American K-12 education.  American spending per pupil exceeds $11,500 per student, 35% higher than the average developed country. America spends just under 7% of its Gross Domestic Product on secondary and post-secondary education, among the highest in the world.  This number has increased over time, an increase that far outstrips inflation and that increases in real and relative terms compared to most other public spending.  Our educational system is among the most lavishly funded system in the world. Yet average educational attainment is still rather pitiful. Why?

Any analysis of common core must separate the content of the standards from the idea of standards and the political process used to adopt and implement them.

There is more than a little sense in many of Common Core’s ideas.  For instance, today elementary students read almost exclusively fiction in their classes; common core standards would have school districts add historical biography.  Another example would be the integration of a more consistent use of language in math teaching that allows for more systematic building on previous concepts.

The political process that Pres. Obama and Common Core advocates such as former Florida Governor Jeb Bush favor to gain adoption of Common Core has undermined the free choice of local governments to adopt Common Core.  Common Core has been spread under the auspices of Pres. Obama’s “Race to the Top” initiative, part of his stimulus bill in 2009.  Under this initiative, states received federal monies and relief from federal regulations in return for their adoption of Common Core standards.  The Obama administration also granted massive funding to testing and curriculum development industry to develop materials to support these standards.  Private foundations also got into the act at that time.  The Gates Foundation was active in supporting the Obama Administration’s efforts to secure adoption of Common Core standards, expending billions of dollars to help states write “Race to the Top” applications and to persuade state officials of the benefits of Common Core.

By 2010, 45 states and the District of Columbia had bought into the Common Core standards.  Most private schools have followed course, in part because they have to given the requirements that they have for accreditation from the state.

Let us leave aside that, at the time Common Core was adopted, there were no pilot tests to see whether it would actually work.  Let us also leave aside more technical worries that Common Core emphasizes skills without content.  Experience teaches that the announcement of standards is very different from implementing them in classroom and that higher state standards have very little to do with educational improvements or high achievement.  Common Core (2009) is but the latest example of national reform designed to fix an unacceptable status quo—it comes seven years after the No Child Left Behind, which came 8 years after Pres. Clinton’s goals 2000 initiative, which came seven years after Pres. Bush wanted to be the “Education President” and announced tough national standards, which came seven years after Pres. Reagan’s “Nation at Risk” report in 1983.   Forty years of reform after reform and the nation is still at risk.  Reform measures have failed for three interrelated reasons.

First, standards-based educational reform efforts subvert local control, which helps secure high educational quality at a good cost.  Interested citizens can provide a kind of check on school districts just as paying customers provide a check on private industry.  Efforts to centralize education funding and curriculum have fostered disengagement from schools.

Second, disengagement from educational decisions has also proceeded from the decline of marriage and family life in America.  Schools are reflections of their student populations, and if parents are not reinforcing educational goals at home, then students are less likely to be able to do the job.  Study after study shows that all the standards in the world are nothing compared to a solid home life for children.  After cataloguing declining educational attainment, scholars at the Educational Testing Service concluded that “it is hard to imagine progress resuming in reducing education attainment and achievement gap without turning these family trends around” by “increasing marriage rates and getting fathers back into the business of nurturing children.”

Third, there is a sense in which educational attainment is rather high, if we limit our analysis to those that are products of stable, two parent families.  This has been brought about not by forty years of reform, but rather by the advantages accrued from intact families.  Improving attainment for students without stable home lives is the great challenge and standards have very little to do with that problem.

Educational attainment is a reflection of culture.  As Charles Murray has written, America is, in this respect, “coming apart.”  The standards-based approach thinks of education as a technical matter, while evidence and experience shows that education is a matter of character and perseverance and ambition.  For this reason, Common Core is bound to fail.  If you do not like Common Core another reform effort is just around the corner.

The views expressed here are those solely of the author and do not represent Boise State University or R|W Investment Management.

Information in this article is derived from:

The National Center for Education Statistics “Education Expenditures by Country” http://nces.ed.gov/programs/coe/indicator_cmd.asp

The Organisation for Economic Co-Operation and Development “Education at a Glance 2014” (page 216) http://www.oecd.org/edu/Education-at-a-Glance-2014.pdf

The Washington Post “How Bill Gates pulled off the swift Common Core revolution” by Lyndsey Layton http://www.oecd.org/edu/Education-at-a-Glance-2014.pdf

Barton and Coley, “The Black-White Achievement Gap: When Progress Stopped,” Policy Information Report. Educational Testing Service, July 2010, p. 35.

 

Dr. Scott YenorDr. Scott Yenor
Professor of Political Science
Boise State University
[email protected]

Scott Yenor is Professor of Political Science at Boise State University, where he teaches courses in political philosophy, American political thought, and constitutional law.  He is also Director of the American Founding Initiative, which aims to bring ideas of limited government and classical liberty to today’s university.  His publications include Family Politics: The Idea of Marriage in Modern Political Thought (Baylor, 2011), which concerns the way in which the ideas of contract and human autonomy have eclipsed the idea of marital unity in modern political thought. He is currently working on three books—one applies the idea of marital unity to today’s family policy; another concerns American Reconstruction; and the last is about the political thought of David Hume.   He lives in Meridian Idaho with his wife Amy and five children—Jackson, Travis, Sarah, Paul, and Biscuit (Mark!).  He enjoys basketball and reading (especially Russian novels and he has pledged to read only Russian novels until January 2017).

The Global Credit Bubble

It’s fundamental – if you want a higher return on your capital you have to take more risk.

The risk-return tradeoff in financial markets has been around forever. What many in today’s global markets may have missed is that this fundamental principle doesn’t go away when you take on debt. Individual investors and government policy makers alike seem to think you can put borrowed capital to work without any additional risk.

The financial markets always find a way to correct this misunderstanding. Market volatility in Greece, China, and the United States points to the additional risk of using borrowed capital.

To understand the principle consider two businesses that are identical in all aspects except one. Firm A uses only investor’s capital to operate, while Firm B uses 50 percent debt.  When Firm A earns 10 cents, each investor makes a 10 percent return on each dollar of their capital. Investors in Firm B, however, earn nearly 20 percent because they have less capital employed.

The problem arises when these businesses face a downturn. A 10 percent decline in earnings reduces Firm A’s capital by 10 percent, but reduces Firm B’s capital by more than 20 percent because the debt holders still need to be paid their interest.

What’s true for the investors in these hypothetical businesses is also true for entire economies that take on debt. The economic and investment outlook for the remainder of this year is heavily dependent on how the debt situations in Greece, China, and the United States play out.

At the end of June the Greek government failed to make a scheduled debt payment to the International Monetary Fund. The government in Athens has clearly overextended itself, running excessive budget deficits for decades and promising generous pension benefits for its workers.

Historically, governments addressed debt problems by devaluing their currency. This is the biggest risk of the Greek crisis for all investors. If Greece decides to no longer use the Euro currency it should precipitate a fall in the value of the Euro and a corresponding rally in the value of the US dollar. Such exchange rate changes will likely lead to declines in both commodity and world stock prices.

The end of the June also saw financial market turmoil in China. The run-up in Shanghai stock prices over the past year was fueled in large part by borrowing on the part of small, individual investors who wanted to invest in the stock market. Then, when the market started to sell off in late June and early July the Chinese government responded with more cash for the state-backed margin financing entity — China Securities Financing Corporation (CSFC).  The CSFC lends funds to brokerage firms for the specific purpose of lending to investors for stock purchases.

China’s overall debt load is now nearly three times its annual economic outputiii. The country could also try to devalue its currency in response, but the Chinese government has officially stated otherwise. The government announced earlier this year it would like its currency, the Yuan, to become what is known as a reserve currency. When more institutions around the world hold a currency in reserve that country benefits from more trade and lower interest rates.

The United States continues to have its own debt problems. In response to the housing crisis the US federal government took over the large mortgage financing entities and the US Federal Reserve embarked on unprecedented government and mortgage bond-buying spree. There is now more than $23 trillion of US government-sponsored debt outstanding[i], which amounts to 130 percent of our annual output. The burden of this debt stays low if interest rates are also low.

That could be changing soon. Policy makers at the US Federal Reserve began discussing in June the potential for raising interest rates. Minutes from the Federal Open Market Committee meeting show that at least one member was ready to raise interest rates now, but “expressed a willingness to wait another meeting or two.” [ii] Higher interest rates will make the government debt burden harder and raise the value of the Dollar. Just as with the Greek situation above, the effect should be declines in both commodity and world stock prices.

The debt problem is not limited, however, to just these three countries. According to the McKinsey Global Institute, global debt has grown by $57 trillion since 2007, with most major economies having higher levels of borrowing relative to their economic output than they did before the financial crisis of 2008.[iii]  As with the US, most of this debt is government-issued.

Some economists have argued that government debt is not a problem and that we should issue more to finance government spending. Paul Krugman, for example, has argued that we should not worry about government debt because it is “money we owe to ourselves.”[iv] Not true if future generations (not us) have to pay it back to others (again, not us).

Government budget deficits and increasing debt is more like taxing ourselves, and higher taxes reduce economic growth and lower financial returns. Economists Robert Barro and James Buchanan, among others, have shown that increasing government debt increases the likelihood of financial crises and reduces long-term growth.

It’s fundamental – societies have increased the risks in the economy and financial markets by using debt with the hope of generating better returns. It hasn’t worked. Economic growth is slow, bond returns are anemic, and annualized stock-market returns over the past decade are still below historical norms.

Expect slow growth and low financial returns unless government spending and debt declines.

The views expressed here are those solely of the author and do not represent Northwest Nazarene University or R|W Investment Management.

[i] http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm and http://www.treasurydirect.gov/govt/reports/pd/pd_debtposactrpt_0615.pdf

[ii] http://www.federalreserve.gov/monetarypolicy/fomcminutes20150617.htm

[iii] http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging

[iv] http://www.nytimes.com/2015/02/09/opinion/paul-krugman-nobody-understands-debt.html

 

Peter R. Crabb, Ph.D.Peter R. Crabb, Ph.D.
Professor of Finance and Economics
Department of Business and Economics
School of Business, Northwest Nazarene University
[email protected]

Dr. Crabb holds a Ph.D. in Economics from the University of Oregon and an MBA in Finance from the University of Colorado. His research in economics and finance is published in the Journal of Business, the Journal of Microfinance, and the International Review of Economics and Finance, among others. Dr. Crabb lives with his wife, Ann, and their four children in Canyon County, Idaho. Dr. Crabb’s regular Financial Economics column is published by the Idaho Statesman. Previous work experience includes international trade, banking, and investments.

College Readiness and the Common Core

There are many reasons to be pessimistic about the state of American secondary education.  By some measures, only a quarter of American high school students have the skills they need to succeed at college or in a career.  Perhaps getting under the hood of some numbers might make us all better thinkers about education.

The ACT and SAT tests are designed to measure college readiness.  According to recent studies conducted by the organizations behind these tests,* an ACT or SAT score corresponds to success rates at college.  A 22 on the ACT’s reading or math test, for instance, corresponds to a 75% chance of earning a C in a college math course and a 50% chance of earning a B.  Only 44% of those taking the ACT in 2012 (the last year for which we have data) were college ready in math and reading.

Here is the kicker.  When students go to college, they take classes in reading, math, science and English.  However, only about a quarter of high school graduates taking these tests nationwide demonstrate college readiness in all of the relevant areas and nearly one-third of test takers are not ready in any of the four areas. This means that they are very unlikely to finish college.

The movement among the ACT and SAT testing complex is to align curriculum in high schools more directly to the tests the students will be taking to demonstrate college readiness.  High school students that take a “core curriculum” aimed at the tests—both tests tout—are more likely to do well on the tests and be “college ready.”  Here are the statistics: According to the College Board, graduating from a high school with a core curriculum increased success rates on the SAT by about 15%.  More core equals more college readiness, or so the argument goes.

This is where the Common Core State Standards policy fits in: It promises to (1) increase the number of students in core curricula and (2) increase the rigor of local core curricula by aligning curriculum and teaching techniques to national standards.  Carrots of federal and foundation monies and exemptions from old federal testing are attached to adopting this common core; school districts around the country and state are hopping on board.  Curriculum will be revised.  New tests will bring accountability.  Teacher evaluations will be tied to improving outcomes.  Data will be used to make decisions.

This will also have an effect on higher education below the surface.  Though I did not know it until I became a professor, the key to college “quality” has been the accreditation process—a process that has driven much of the growth in college administration in the last twenty years. An accreditation agency verifies that a degree from any educational institution is held to particular standards, academic and otherwise.  High schools are accredited.  Colleges and universities are accredited.  What goes on in the curricula in high schools and universities are largely shaped by accreditation agencies, who tell the educational institutions what they have to do in order to grant degrees and receive federal monies or loans.  The Common Core represents an effort to centralize the accreditation process—with high school curriculum and testing for colleges in the form of the SAT and ACT.  Both the ACT and SAT organizations participated in developing Common Core standards and tests and promise to align their “college readiness” tests with the Common Core, which aims to promote both college and career readiness. It is certainly possible that college curricula will also have to be focused around a common set of standards.

As the accreditation standards come to reflect the same standards of Common Core, the differences among colleges and universities will tend to be minimized and, so the theory goes, they will all get better.  Those universities accredited in the post-Common Core process will come to resemble one another more and more.

These are the trends, broadly speaking, in the American educational system for dealing with America’s yawning “competence gap.”  Will the effort to institute a Common Core, a K-12, K-16 or K-20 approach to education, improve American competences?  What effects might this approach have for college planning?  We will consider these questions next quarter.

The views expressed here are those solely of the author and do not represent Boise State University or R|W Investment Management.

*Information in this article is derived from:

The ACT’s Annual Report entitled “The Condition of College and Career Readiness”
http://www.act.org/research/policymakers/cccr14/pdf/CCCR14-NationalReadinessRpt.pdf

The College Board’s “2013 SAT Report on College & Career”:
https://www.collegeboard.org/sites/default/files/sat-report-college-career-readiness-2013_0.pdf

An article by Libby A. Nelson, “The Common Core on Campus:”
https://www.insidehighered.com/news/2013/05/03/common-core-curriculum-k-12-could-have-far-reaching-effects-higher-education

Dr. Scott YenorDr. Scott Yenor
Professor of Political Science
Boise State University
[email protected]

Scott Yenor is Professor of Political Science at Boise State University, where he teaches courses in political philosophy, American political thought, and constitutional law.  He is also Director of the American Founding Initiative, which aims to bring ideas of limited government and classical liberty to today’s university.  His publications include Family Politics: The Idea of Marriage in Modern Political Thought (Baylor, 2011), which concerns the way in which the ideas of contract and human autonomy have eclipsed the idea of marital unity in modern political thought. He is currently working on three books—one applies the idea of marital unity to today’s family policy; another concerns American Reconstruction; and the last is about the political thought of David Hume.   He lives in Meridian Idaho with his wife Amy and five children—Jackson, Travis, Sarah, Paul, and Biscuit (Mark!).  He enjoys basketball and reading (especially Russian novels and he has pledged to read only Russian novels until January 2017).

The Higher Education Bubble?

Parents see higher education as an investment in the future of their children.  There is a lot of evidence for this view.  Unemployment rates for those with a high school degree are much higher than those with a college degree (12.2 unemployment for high school only; 3.8 for college graduates), while earnings for college graduates outstrip the earnings of those who have only completed high school (high school-only graduates earn about 62% of the income of those who finished college).  The gap is widening with time as well: The number was 81% in 1965.*

What is going on here, as a recent Pew Research Center survey shows, is a rising cost of NOT going to college.  The college diploma is more valuable in relative terms than in absolute terms.  Economic opportunities, income and employment levels of those with only high school diplomas, have decreased in real terms in the past twenty-five years. Going to college is like standing up at a football game: when everyone else stands up, you have to stand up if you want to see.  Not going to college is like sitting while those around you are standing and blocking your view.  Those standing are not necessarily better off because they are standing, but they are able to see.

Students in 1961 averaged 25 hours per week of study time; in 2003 it was 13.  In 1961 more than two-thirds of students studied more than 20 hours a week; in 2003 only 20% did, while more than one-third of students spent less than 5 hours a week studying. Half of students in the late 2000s had never been required to do 20 pages of writing in a class, and nearly that many had not done more than 40 pages of reading per week in a class.  These statistics coincide with an actual decrease in the amount of learning that goes on in college.  36% of all college graduates show no improvements in writing, thinking or reading skills over the course of their entire college careers.  All of this coincides with great increases in the number of As and Bs earned on college campuses.

More highly selective colleges do generally have classes with more writing and reading.  Take it from a university professor at a state school: requiring students to read and write at these levels decreases their grades significantly, though I have faith that it increases their learning.  Students do not want to do this much work, and professors, generally, do not want to grade it or assign it.  Students can find an easy path through the requirements of all modern universities.

Increasing costs combined with increasing irrelevance of the education suggests to many that we are living through a higher education bubble.  A higher education bubble is emerging because colleges depend on enrollments to sustain their operations. The numbers of students going to college is decreasing (a decrease of almost a million students in the past two years).  This means that universities must increase prices in order to meet budgets.  (The federal government abets these increases in price through loans.)  Universities are raising prices at a time when the value of their product is coming under increasing scrutiny and when alternatives to brick and mortar universities are emerging.  Two-year schools, vocational training, on-line education, apprenticeships and perhaps other ways of delivering the credentials at a lower cost are arising and will continue to arise.  Such educational options may indeed have more immediate relevance to the career aspirations of many students.  This will lead to the bubble bursting for many universities.

The invaluable liberal education based on Great Books that many of us received on the university level is mostly a thing of the past: one must strive to get that at the K-12 level nowadays, since there are so few places that offer it at the university level.  Aside from liberal education, there is very little justification for a four-year, career-oriented degree from the current educational establishment (parents should also recognize what is called a liberal education is often not a liberal education).

Parents should be open to such alternatives to a four-year college experience for their children.  Parents should also recognize their investment is not just in preparing financially to pay for college.  They must continue to oversee that investment when their students are on campus.  This oversight consists of making sure that their children are getting better and challenging themselves intellectually.  It includes discussing their decisions of majors and career aspirations when they are on campus so the financial investment leads to gainful employment.

The modern economy is more about what you know than where you went to school.  Investing in higher education must, more and more, mean making sure children are prepared for this what-you-know reality.

*All data and statistics in this article are from Statistically Adrift: Limited Learning on College Campuses by Richard Arum and Josipa Roksa, 2011.

The views expressed here are those solely of the author and do not represent Boise State University or R|W Investment Management.

Dr. Scott YenorDr. Scott Yenor
Professor of Political Science
Boise State University
[email protected]

Scott Yenor is Professor of Political Science at Boise State University, where he teaches courses in political philosophy, American political thought, and constitutional law.  He is also Director of the American Founding Initiative, which aims to bring ideas of limited government and classical liberty to today’s university.  His publications include Family Politics: The Idea of Marriage in Modern Political Thought (Baylor, 2011), which concerns the way in which the ideas of contract and human autonomy have eclipsed the idea of marital unity in modern political thought. He is currently working on three books—one applies the idea of marital unity to today’s family policy; another concerns American Reconstruction; and the last is about the political thought of David Hume.   He lives in Meridian Idaho with his wife Amy and five children—Jackson, Travis, Sarah, Paul, and Biscuit (Mark!).  He enjoys basketball and reading (especially Russian novels and he has pledged to read only Russian novels until January 2017).

You Can’t Keep the Dollar Down

It’s been said, “You can’t keep a good man down.”  In the financial markets, that man is the US dollar.

In response to the financial crisis of 2008, the monetary policy of the Federal Reserve has been one of the attempts to increase inflation, but this objective has not reduced the purchasing power of the US currency against others. Despite a long period of supplying the financial markets with many new dollars the value of our currency is strong.

Since 2012 when the Fed first considered a third round of bond-buying, or “quantitative easing”, the dollar has gained 8 percent and 33 percent against the Euro and Yen, respectively. Against all major currencies the dollar is 18 percent higher over these past three years.[1]

One would think that such a change hurts the international trade position of the United States. Such is not the case. US exports of goods and services are 9 percent higher than they were in 2012. The balance on the US Current Account, the broadest measure of our trade balance, is 16 percent smaller.[2]

The value of the dollar is likely to remain high because of issues well beyond the control of US policy makers. The Fed should stay focused on the home economy and seek better incentives for business investment here. We certainly don’t want a currency war.

The strong dollar has led some to claim that other countries are manipulating the value of their currencies to gain an export advantage against the United States. New federal legislation in Congress will allow the government to impose punitive duties on imports from countries showing a pattern of currency manipulation. Similar bills were introduced in Congress in 2011 but never became law.

The strength of the dollar, however, is not due to currency manipulation. The economic outlook outside the United States is simply weaker.

Central banks across the globe have followed the Fed’s lead and started their own forms of quantitative easing programs. The Bank of Japan, The European Central Bank, the Bank of China, as well as monetary authorities in Australia and Canada, have all taken steps to stimulate spending and investment in their domestic market. These low-interest policies have the additional effect of lowering the value of their currencies.

A true currency war would entail direct intervention by central banks in the market foreign exchange. The Swiss National Bank did try for some time to fix the Franc’s value against the Euro, but that program ended abruptly last month. There is no evidence central banks worldwide are actively buying and selling currency to push values lower against the dollar.

The strength of the dollar, or weakness of all the other major currencies, is evidence of the structural problems in much of the world’s economies.

Japan continues to struggle with a lack of consumer demand and burdensome labor market regulations. European finance ministers continue to fight against profligate government spending in Greece and other Eurozone member countries.

Meanwhile, China is exporting lower inflation to the rest of the world through subsidies to export-oriented industries. Officials there are trying to overcome their mistake of the government funded housing bubble. The economies of Australia, Canada, and Norway are reeling from lower commodity prices, especially in the oil market. But this trend is good for all of us. New technologies help us find more oil and other commodities more easily.

The large gap in the economic outlook between the US and the rest of the world can be seen in the bond markets.

Yields in the global bond markets are nearly 2 percent less than those in the US. Shorter-term bonds in much of Europe yield negative returns. Most recently, Sweden’s central bank lowered interest rates into negative territory and announced a new bond-buying program. The spread between 10-year US Treasuries and the German Bond yields is nearly 1.7 percent.[3]

As economist Irving Fisher first formulated and explained a century ago, yield spreads differ for one of two reasons – real returns or inflation expectations. That is, the yield on one country’s bonds will be higher than another if either inflation is expected to be higher or the real, inflation-adjusted return is expected to be greater.

Fisher posited that real returns would not differ for very long. When investors see better returns after inflation in one country for any period of time they move capital from the lower real-return countries, equalizing the real return over time.

So right now, the real returns look better in the United States. The structural problems outlined above are driving capital out of those countries and into the US, driving up the value of the dollar. It will take some time, and perhaps a sharp drop in the value of financial assets across Japan, Europe, and elsewhere, but returns will equal out.

For the US investor this situation calls for patience and global diversification. Individual investors, and even professional money managers, should not try to beat the highly-volatile and competitive currency market.

For now, even the Fed can’t keep the dollar down. Over time, global financial markets will adjust.


The views expressed here are solely those of the author and do not represent Northwest Nazarene University or R|W Investment Management.

 

Peter R. Crabb, Ph.D.Peter R. Crabb, Ph.D.
Professor of Finance and Economics
Department of Business and Economics
School of Business, Northwest Nazarene University
[email protected] and @prcrabb

Dr. Crabb holds a Ph.D. in Economics from the University of Oregon and an MBA in Finance from the University of Colorado. His research in economics and finance is published in the Journal of Business, the Journal of Microfinance, and the International Review of Economics and Finance, among others. Dr. Crabb lives with his wife, Ann, and their four children in Canyon County, Idaho.
Dr. Crabb’s regular Financial Economics column is published by the Idaho Statesman.
Previous work experience includes international trade, banking, and investments.

[1] http://research.stlouisfed.org/fred2/release?rid=15
[2] http://research.stlouisfed.org/fred2/series/IEABC
[3] Retrieved February 13, 2015; http://www.wsj.com/mdc/public/page/2_3022-govtbonds.html?mod=mdc_bnd_gvtbnd

Did I Miss Something?

Did I miss something?

In my outlook letter at the start of this year I expressed concern with the ongoing federal budget deficit and high outstanding public debt.  A large body of economic theory and evidence from around the world shows that high-levels of public debt lead to extended periods of slow economic growth.

The U.S. economy is not immune to these effects.  Since 2010 U.S. real gross domestic product has grown at an average annual rate of 2 percent, compared to an average of 3 percent in the decade prior to the global financial crisis.[1]

A one percent difference may not seem like much, but the massive build-up in federal debt during 2009 and after has long-term consequences.  When the economy grows at 3 percent per year the living standards of the young are twice that of their parents.  But when the economy grows at only 2 percent it takes two generations before living standards double. Slow economic growth can result in a “lost generation.”

As we enter the last quarter of this year economic and financial market indicators suggest my concerns may be unwarranted. Labor market conditions are improving, bond prices indicate low inflation expectations, and stock prices reflect relatively high expectations for earnings growth. I may have missed something.

At 5.9 percent, the U.S. unemployment rate is now in the range (4 – 6 percent) that many economists consider normal. There is always some unemployment as new businesses start and old close, leading to displacement of some workers. A five percent rate seems normal.

However, when you couple a declining unemployment rate with a declining labor force participation rate the situation is less promising. The percentage of U.S. adults in the workforce has declined from 66 percent in 2007 to less than 63 percent today. In the last seven years only 1 million new jobs have been created despite an increase in population of nearly 18 million.[2]

There also doesn’t seem to be an inflation problem. Interest rates on U.S. Treasury bills, notes, and bonds remain well below historical levels. The yield spread, or difference between rates on short-term and long-term U.S. debt, predicts relatively low inflation for the next decade. [3]

Meanwhile, stock prices as measured by the Dow Jones Industrial Average are 20 percent above the highs reached in 2007, and stock valuations are above historical averages. Higher stock valuations indicate expectations for faster economic growth.

These financial market indicators are just as misleading as the low unemployment rate.  Low interest rates are the result of financial repression on the part of monetary officials and U.S. stock prices are additionally supported by higher than average capital flows from foreign investors.

Financial repression occurs when government authorities channel funds from one area of the economy to another, often the government’s own debt. Since 2008, large purchases by the Federal Reserve and increasing federal government debt have suppressed risk measures in the stock market and created a high level of uncertainty in the overall economy.

After their most recent meeting, the Federal Reserve’s Open Market Committee announced the end of a large bond purchasing program known as quantitative easing. The Fed said it will, however, continue to keep short-term interest rates near zero for a “considerable time.”[4]

These low short-term rates should create strong incentives for borrowing, investment, and consumption, but monetary policy is not as effective as many believe The Fed can affect what is called the monetary base, but this may or may not change the money supply. Since 2007 the monetary base has increased nearly fivefold[5], but the money supply has risen only 63 percent.[6]

The Fed is still pushing on a string. No matter how low rates stay and no matter how many bonds the Fed does or does not buy, monetary policy will always be an imperfect tool.

While the Fed supports bond prices foreign investors are pushing up stock prices. The most recent data on foreign investment shows that the U.S. is a favored destination for capital. The value of foreign holdings of U.S. equity securities has more than doubled since 2007. As a percent of total outstanding, foreign holdings of U.S. equities grew from 9.2 to nearly 13.7 percent.[7]

Funds are flowing to the capital markets of the United States because the outlook for economic growth is worse elsewhere. Financial repression is even higher in Japan and the Eurozone, while also rising in the developing markets of China and elsewhere.

Indicators in the U.S. labor, bond, and stock markets may all look good relative to historical averages, but a deeper look tells a different story. The debt problem remains. For conditions in these markets to improve, and economic growth return to its 3 percent long-run average, fundamental policy changes are needed.

We didn’t miss anything. When government spending and public debt start declining, the labor and financial markets will reflect a truly healthy economy.

Peter R. Crabb, Ph.D.Peter R. Crabb, Ph.D.
Professor of Finance and Economics
[email protected] and @prcrabb

The views expressed here are those of solely of the author and do not represent Northwest Nazarene University.

[1] http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

[2] http://www.bls.gov/news.release/empsit.nr0.htm

[3] http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/default.aspx

[4] http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm

[5] http://research.stlouisfed.org/fred2/series/BASE

[6] http://research.stlouisfed.org/fred2/series/M2

[7] http://www.treasury.gov/ticdata/Publish/shla2013r.pdf