By now most people have heard about rising income inequality in the US. Looking at the data, it’s clear that the people at the top have done much better than the middle class in recent decades.
Between 1979 and 2007, inflation adjusted after-tax incomes for the bottom fifth of Americans have increased 16%. For the middle fifth, income gains have been slightly higher at 25%. But for the top fifth (and especially the top 1%) the gains have been dramatically higher. How did this happen?
The US Federal Reserve keeps data going back to 1947 for American productivity and compensation.
Between 1947 and the early 1970′s, worker compensation kept pace with increases in productivity. Beginning in the 1970′s, however, the average worker began to fall behind. The latest figures show that worker compensation is now 33% lower than it would have been – had it kept pace with productivity. Where did that 33% go?
Returning to the income differences between 1979 and 2007, we can calculate what incomes would have been without the increase in income inequality.
Doing this, we find that incomes for middle and lower income households would be between 23% and 34% higher than they are now – roughly in line with the gap between compensation and productivity. It seems that a large part of income inequality can be explained by the people at the top receiving most of the productivity gains since the 1970′s.
The exchange rate between the US and Canada has varied widely over the last few decades. Looking at monthly averages since 1990, the Canadian dollar has ranged from a low of 62 cents in February 2002 to a high of $1.04 in July 2011 with the average over the 22 year period being 79 cents.
Is there any way to determine what this rate should be in order to know when the time is right for cross-border investing? As Warren Buffett says, “Price is what you pay. Value is what you get.” The current exchange rate reflects the relative price of the two currencies. The goods and services each currency can buy reflects their values. As with all assets, when the price of a currency is low relative to its value, it’s a good time to buy. But how do you determine the value of a currency? One of the most popular ways is by using Purchasing Power Parity (PPP).
PPP is an attempt to calculate the exchange rate which results in equal buying power for each currency. For example, if a basket of goods costs $100 CAD in Canada and that same basket of goods costs $85 USD in the United States, both currencies will have the same purchasing power with an exchange rate of $1.0 CAD per $0.85 USD. In this situation, if the actual exchange rate were $1.0 CAD per $1.0 USD, then the Canadian dollar would buy 17.6% more than the US dollar – implying that the CAD is 17.6% overvalued.
Each month, the Organization of Economic Cooperation and Development (OECD) calculates PPP for each of the OECD countries. Their latest data indicate the current exchange rate should be $1.0 CAD per $0.78 USD – coincidentally this is almost the same as the average exchange rate since 1990. At the time of this writing, the actual exchange rate is $1.0 CAD per $0.97 USD implying the Canadian dollar is 24% overvalued.
Although there are different methodologies for computing PPP and no method is completely accurate, 24% is significant. Additionally, since the current value of the CAD is also 23% above its 22-year average, it’s safe to say it’s a good time for Canadians to be buying US assets – and a good time for Americans to be selling Canadian.
With all the information Canadians have heard about the US housing bubble and the incredible economic damage it’s bursting has caused, it’s hard to believe they would follow the same path – and yet they have. The average price of a Canadian home currently stands at $362,899 – about 70% more than in the US.
(Note: Canadian realtors typically report average prices while American realtors report median prices. Average home prices in the US are about 20-25% higher than median prices. The current median US price is $169,500 making the average US home approximately $210,000.)
According to a recent article in The Economist, Canadian house prices are 29% overvalued relative to household incomes and a staggering 71% overvalued relative to rents.
Things are even worse in Vancouver, where the latest Demographia Housing Affordability Survey ranks Vancouver the 2nd least affordable city in the English speaking world. According to the survey, the median price of a home in Seattle was $321,500 while in Vancouver it was $602,000. In the year since that survey was published, Vancouver prices have gone up another 7.8% while Seattle has gone down 7.1% – making a home in Vancouver more than twice as expensive as a comparable home in Seattle. This is in light of the fact the two cities are similar in almost every way – including incomes.
How did things get so out of whack? Same way as they did in the US – with a debt fueled housing bubble. Lesson not learned.
How will the situation resolve itself? In all likelihood the correction will also follow the path of the US – a multi-year housing crash which ruins the lives of countless Canadians and takes down much of the economy with it.
There’s been a lot of talk lately about the huge federal budget deficit. Along with that talk has been a lot of confusing and misleading information – accusations of “out of control spending” by the right and “millionaire tax cuts” by the left. But what do the actual numbers tell us?
There really are two stories to tell. The first is the short term problem of depressed tax revenue brought on by the Great Recession – not runaway spending. The second is the longer term problem of spending increases along with unfunded tax cuts. A look at the following graph shows this very clearly:
The red line shows federal government spending (expenditures), while the blue line shows tax revenues (receipts).
The short term deficit is clearly a result of the huge drop off in revenues that started in 2007 when the economy went into recession. There was a bump in spending due to the Stimulus Package which is estimated to have increased the debt by about $825B but revenues are the main issue – and revenues won’t return to their previous levels until the economy fully recovers. Unfortunately, as I will comment on in a future post, it could be a several years before that happens.
What’s also clear from this graph is that the longer term problems are the spending increases and tax cuts which began in 2001. In the years between 1995 and 2001 spending was kept in check while revenues grew – resulting in a few years of budget surpluses (Clinton with a GOP congress – a divided government success story!). Had those rates of spending and taxation been continued, the national debt would less than half of the current total and the government would be in surplus this year! Beginning in 2001, however, the rate of spending doubled to over 6% annually. This spending growth was significantly higher than GDP growth creating an unsustainable path destined to result in long term deficits. At the same time a series of tax cuts in 2001, 2003, 2004, 2008, 2009 and 2010 lowered tax revenues significantly. As a result, the effective tax rates today for all income levels are the lowest they’ve been in decades.
The CBO estimates that, since 2001, spending increases added $5.7T to the national debt and tax cuts added another $2.8T. Together, these two additions to the national debt account for more than half of today’s total.
In order to get back in balance, spending will either need to be cut drastically, or increases must be kept below GDP growth for several years. Considering the fragile state of the current economy, the latter choice would be preferable. Revenues will also need to return to higher levels. Most likely this will mean a tax increase in the not too distant future.