The Asset-Rich, Income-Poor U.S.

Economy:
Similarities/Lessons for Pakistan

Some

By
Inayat U. Mangla
Professor of Finance & C. Law
Western Michigan University
Kalamazoo, MI. 49008, U.S.A
Email: inayat.mangla@wmich.edu
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Background
The Asset-Rich, Income-Poor U.S. Economy :
Some Similarities/Lessons for Pakistan
History repeats itself and conventional wisdom, despite
current global challenges, has continuous merit
We are all familiar with Japans Econ. crash of 1990s,
and its subsequent two lost decades of economic
malaise, recessions and stock market crash
Nikkei 225 dropped from 40,000 to 8,000 (80% ).
Today, around 20,000 - 1% Real growth () despite lowest
level of ST and LT rates in world history.
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U.S. Experience
K. Warsh (June 20, 2014, WSJ) calls Japans experience Balance
Sheet Recession (B.S.R.). This conclusion wasnt forgotten by
U.S. Fed during /after GFC.
What was GFC?: Some facts: Fin. Markets, Fin. Institutions,
, uu , (C.B. / Inv. B), ST-FFR and LT 10Y USGBY before and after.
Policy response: Fed engineered an extraordinarily loose M.P.,
what can be described as Balance Sheet Recovery. The Policy
started in 2008 in various forms and shapes QE1, QE2, Operation
Twist and QE3.
Summary of all these developments can be seen in the Feds B.S.,
which stood at $5T in Jan. 2015, vs. normal average of $0.7T. a
nice happy birthday on Feds 100 years.
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Insert Fed B.S.

Fed B.S. Recovery- An

Evaluation
Fed officials have said several times that among other benefits,
its QE programs have helped boost U.S. equity prices.
Critics of Feds B.S.R. argue that it hasnt produced business
investment, it has been an opportunity killer for the U.S. labor
force.
The Fed assures us- even with improved inflation dynamics,
credit markets have priced for perfection, and stock prices are
at a record level.
DJIA @ 18,000, S&P500 @ 2100 and NASDAQ @ 5000 on April
8, and some similar consolation for Pak KSE @ 30,000 with
P/E=25.8 with historic average 15
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Balance Sheet Recovery:

Evaluation
The agg. wealth of the U.S., H.H., including stocks and real
estate holdings hit a new high of $82T-a whopping of $26 T
in wealth since 2009. No wonder most analysts on Wall
Street applaud the Feds unrelenting balance sheet recovery
strategy.
The Feds extraordinary tools (QEs) are far more potent in
goosing balance sheet wealth than spurring real income
growth. Bernanke has asserted that higher stock prices are
an outcome of Fed purchases of U.S. Treasuries.
However, another approach of research suggests a
different perspective, e.g. PIMCO. Based on their analysis,
QE has not been the driving force behind rising equity prices
in recent years. They found that since 2009, corporate profits
have had a more direct relationship to stock prices.
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 Coming back to the critics of Feds policy, it provides little comfort for middleclass families and small businesses that must rely on their income statements to
pay the bills. About half of American households do not own any stocks and more
than one-third dont own a residence.
The most recent March 2015 employment report reveals the troubling story for
Main Street. Only 120,000 jobs were created in March, income for most Americans
remains under stress, with only modest improvements in hours worked, and
average hourly earnings.
With the so-called improvement in the labor market, and the unemployment rate
dropping to 5.5%, Fed faces two big policy questions:
When to raise rates, and how to go about raising them.
Federal funds futures, which price off Fed policy expectations, imply the target rate
will be 1.0% by August 2015 vs. zero today.
The Fed may end up lifting rates first and dealing with its $5T balance sheet later.
Why? Conventional mechanism of excess reserves will not work.
Yellen, Fed Chair, referred to a broader measure of called U-6, which includes
part-timers looking for full time work and people who want a job but havent been
looking. U-6 has fallen sharply but is still historically high 12.1%. Its taken a full 84
months for the number of people working to get back to its previous peak, in 2007,
a discomforting postwar record.
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U.S. Corporations
Meanwhile, U.S. corporate CEOs have used financial engineering
debt financed share buybacks, M&A etc., instead of capital
investment in property, plants and equipment. In 2014, U.S.
corporations added more than $2T of new debt e.g.:
Apple, GOOG, CISCO,ATT, Pfizer etc., including even some banks.
Some of these corporations paid a lower YTM on these bonds than 10
year U.S. Treasury yields.
Institutional investors extend their risk parameters to beat their
benchmarks.
Retail investors belatedly participate in the rising asset-price
environment, and are forced to take more risk.
Simultaneously, U.S. corporations are loaded with cash of $3T, and
globally more than $4.5T- a cash headache for organizations.
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 All of these above-mentioned strategies have lifted

balance-sheet wealth, (B.S.W.) at least for a while.
But real economic growth - averaging just a bit
above 2% for the sixth year in a row - remains
sorely lacking.
Higher asset prices are not translating into
meaningful increases in capital expenditures.
The weak growth in business investment is proving
to be an opportunity killer for U.S. workers.
The result is those with jobs have some job security
but they are less willing to run the risk of finding a
better opportunity, or negotiating for higher wages.
What matters is the quality of jobs!
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Jobs are not enough

The malaise in the labor markets, and muted business investment
help explain why productivity measures are 1.5 percentage
point below the historical norm. e.g. 1.5% VS 3% in 1990s.
Higher productivity implies increased efficiency in output per
worker- a hallmark of the U.S. economy for the 1980s, 1990s and
early 2000s.
Productivity is growing more slowly, averaging a little over 1% since
the recovery began, about half the average of 2.5% from 1947 to
2007. But productivity growth had begun to slow even before the
recessions, since around 2005. John Fernald of the Fed (2014)
attributes this to the waning of the IT revolution.
I encourage graduate students to calculate productivity for Pak.
economy from 1980s until present and compare it with its peer
economies of S.E. Asian countries. You will find similar rather
more declining output per worker.
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 The Feds latest forecast is for the U.S. economy to grow

at 2% during this decade; and the unemployment rate to
fall to about 5.5% by the end of 2015.
If Feds scenario finally comes to pass, interest rates
are likely to move meaningfully higher across the yield
curve. The money pouring into the financial markets may
be redistributed in part to the real economy.
Therefore, stocks, leveraged loans and real estate
are likely to be re-priced in a higher interest rate
regime.
If rates move quickly or unexpectedly, the glorified
balance-sheet recovery could suffer a blow.

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F.M. Shock
What if there is an unexpected financial shock that
causes the economy to derail in the next two years?
This could happen due to geo-political factors, too quick
risk in interest rates and inflationary expectations.
The Fed would surely be called upon to bolster asset
prices and stimulate the real economy.
It is an open ended question, but would a return by the
Fed be effective?
The common view is that neither Wall Street nor Main
Street would be comforted by a return to QuantitativeEasing.
My own view is that such a shock has a higher probability
b/c. . . .
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Balance Sheet Wealth

Balance Sheet wealth is sustainable only when it comes
from earned income, and not from Financial Engineering
and government fiat.
Wealth creation comes from strong sustainable growth
that turns a proper mix of labor, capital and technology into
productivity, productivity into labor income, income into
savings, saving into capital, capital into investment, and
investment into asset appreciation.
This is good old macro and microeconomics. Concepts
of Production Function and Slow Steady State growth models.
Unfortunately, this too has not been the path of Pakistans
economic growth.

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U.S. and Pakistan

economies
Hence, the U.S. needs an exit strategy from 2%
or less growth trap of the last seven years.
The Pak. economy needs to get out of a slow
growth rate of 3.8%. (Mangla 2011) as there
are No short-cuts through Fed/SBP or MOFengineered Balance Sheet wealth creation.
The sooner the Fed exits its extraordinary
monetary accommodation, the sooner
businesses can get back to business and labor
can get back to work.
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Some Comparisons
What is the difference between 2% economic
growth and 3% growth in the U.S. economy?
Or
3.8% VS. 7-8% growth in peer economies of
Pakistan?
The real difference is one between a balancesheet recovery that helps the well-to-do and an
income-statement recovery that advances the
interests of all citizens.
The question is: What have we done to improve
macroeconomic policy to achieve these target
growth rates?
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Monetary vs Fiscal Policy

Despite all the merits of M.P. and F.P. which Keynes (1936)
and Post Keynesian told us, there are limits to what M.P.
alone can achieve.
The fact is that M.P. is not limitless. The first Nobel L.
Tinbergen (1968) alluded to this by requiring the equality
of # of instruments needed to achieve # of goals.
Effectively any Central Bank has one tool ( M or R-rate).
Thus, it can achieve only one target-perhaps price stability.
It is also imperative to know how economic policy affects
the real econ. activity an issue politicians and central
bankers grapple with any financial crisis, or B.S. crisis of
Pakistan which have occurred regularly within 7-8 year
cycles.
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Monetary vs Fiscal Policy

Two famous economists, and Nobel winners, Sargent and
Simms (SS) presented their empirical research on cause and
effect of macro-economic policy. Messers SS developed models
that C.B. and policy makers use to analyze effects from tax
increases to interest rate cuts.
The core message of SS research is: that the world of
economics is more interconnected than traditional
models recognize, and that economic policy must
reflect these interconnections. Central banks cannot
resolve economic crises alone; their policy must be supported
by fiscal policy, which is controlled by legislators.
To expect more from M.P. without proper support from
F.P. is illusionary and political stunt by policy makers
and politicians (Political Economy) .

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Global Liquidity Trap

Despite the huge budget deficits in the U.S. and
other G.7 economies, there is NO crowding out
because of global supply of liquidity, but perhaps
not in the case of Pakistan.
Even in EM/economies, this holds true to a
certain
Any meaningful recoveries in global economies
need more prudent role of F.P. and tax reforms,
structural reforms in labor market and political will
of making tough choices, which is lacking.
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U.S. Economy
The US economy is weak for a number of simple
reasons and does not need multivariate regressions
to see them.
First, a great deal of business activity that used to
be conducted in the U.S. has left the U.S. for China,
Mexico and large parts of Asia because of high
corporate taxes, higher U.S. wages and excessive
regulations which discourage investment.
Second, a relatively declining educational system,
incapable of providing qualified workers for industry.
Third, an oversized government, leading to a
redistributionist psychology which badly allocates K.
Fourth, anti business growth regulation.
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 Ignoring the U.S. political involvements and its related

costs, some examples of these redistributions
include: Massive public and private sector debt
(currently 348% of GDP, not including U.S. unfunded
liabilities of Medicare, Social Security, prescription.)
In the 21st century, we have seen dramatic
monetary-based expansions, an overleveraged
and almost out-of-credit consumer, devastating
annual budget deficits and perennial current
account deficits that are financed by the dollar
serving as a world reserve currency.
This cannot go on forever.
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Stock Markets/Asset Prices

Having described this pessimistic future outlook for the U.S.
economy in this decade, what can we say about asset prices?
My simple answer: As corporate earnings/profits are the milk and
mother of stock prices, it does not take a Ph.D. to predict that
asset prices are going to fall.
Financial pundits are also predicting a Great Crash of 2016, the
third $10T loss this century.
This is called Greenspans black box syndrome, when he
testified before the U.S. Congress in 2008: His famous eight
words: I really didnt get it until very late.
This stock bubble is beyond 1929 and 2007, says John Hussman.
If this is not enough for a steep decline in stock markets, please
have a look at this anecdotal empirical evidence. Call it a
statistical fluke, but at times flukes hold true!

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22

Back to Pakistan
What is the relevance of the U.S. experience and
economic challenges for Pakistan?
There are a number of similarities of economic
challenges faced by Pak. Economy.
However, a fundamental difference between the
two economies is that while there is an ongoing
continuous debate and analysis about macroecon. policy in the U.S. and its evaluation;
unfortunately, there is little discussion about
coherent and consistent policy making in Pak.
Might is right approach.
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The message for

Pakistan
B.S. maneuvering and Financial
Engineering will not work.
The country needs to establish law and
order situation first as a necessary
condition.
We have been living on borrowed time and
money, and ad-hoc decision making in
macro economic management since early1980s
Some examples of my assertions are:
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Pakistans Policy Issues:

Examples
Exchange rate policy and Balance of
Payments/Trade deficit
Budget deficit
Energy Deficit
Circular Debt, Privatization Issues, etc.
Low economic growth rates
High inflation rates
I can go on, but will only focus on Exchange
Rate policy and B.O.P issues for illustrative
purposes.
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B.O.P and Exchange Rate

Policy
Pak. has faced these B.O.P issues at least four-five times

since 1980s (e.g. 1981, 1991, 1997-98, 2002-03, 2013).

Have dealt with these issues only by a piecemeal
approach such as Political and Financial Engineering,
Rent Seeking Behavior, and capitalizing on geo-political
events of the last three decades.
The result: Continuous and repetitive occurrence of
these problems within a cycle of 6-7 years.
Let us look at the most recent B.O.P crisis of 2013 and a
sharp drop in Pak. Currency (Rupee).
Thanks to a series of recent external transactions a $2B
Eurobond sale; secondary offerings of UBL and PPL;
Friendly Money program disbursements of $1.5B from
the World Bank and ADB; IMF new $6.8B fin. facility; and
partial inflows from the 3G, 4G/LTE telecom auctions led
to the boost in capital account and helped offset the
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weaknesses in the current account.

Business Recorder; July 22, 201427

 Most of these recent temporary fixes in the capital

account are what I have called before as Financial
Engineering. Just as Fed has loaded its B.S.; M.O.F and
SBP have increased its B.S. to stabilize external account
and control the exchange rate depreciation of Rs.
More reliance on foreign debt is not the permanent
solution.
Even heavy reliance on domestic debt is a sign of poor
health of the economy.
SBP reports (July 2014) an increase of 44% in domestic
debt, as interest cost of domestic debt increased to
$961 B.
More alarming is debt stock to GDP ratio, which has
increased from 29% in 2009 to 42.2% in 2014.
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Thank you!

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