The Market Mirage

What stock prices do--and don't--tell us about the actual value of a company

One of the hardest-dying ideas in economics is that stock price accurately reflects the fundamental value of a given firm. It’s easy to understand why this misunderstanding persists: price equals value is a simple idea in a complex world. But the truth is that the value of firms in the market and their value within the real economy are, as often as not, disconnected. In fact, the Street regularly punishes firms hardest when they are making the decisions that most enhance their real economic value, causing their stock price to sink.

There are thousands of examples I could cite, but here’s a particularly striking one: the price of Apple stock fell roughly 25% the year it introduced the iPod. The technology that would kick-start the greatest corporate turnaround in the history of capitalism initially disappointed, selling only 400,000 units in its debut year, and the company’s stock reflected that. Thankfully, Steve Jobs didn’t give a fig. He stuck with the idea, and today nine Apple iDevices are sold somewhere in the world every second.

This story illustrates the truth: Stock prices are usually short-term distractions, while true value is built up over time. According to McKinsey, 70% to 90% of a company’s value is related to its likely cash flow three or more years from the present. That makes sense–making money from new inventions takes time. Yet Wall Street analysts, whose opinions help set stock prices, typically base their assessments of a firm on one-year cash-flow projections. What’s more, like all individuals, they have their biases; during boom periods, they tend to believe that corporate earnings will be higher than during bear markets, regardless of the underlying corporate story.

CEOs, who are paid mostly in stock and live in fear of being punished by the markets, race to hit the numbers rather than simply making the best decisions for their businesses long term. One National Bureau of Economic Research study found that 80% of executives would forgo innovation-generating spending if it meant missing their quarterly earnings figures. It’s a system that, as behavior economist and Nobel laureate Robert Shiller puts it, has emerged from “convenience rather than logic.”

That’s not to say that stock prices don’t give valuable insight into what’s driving corporate America. A recent report from the Office of Financial Research (OFR), a government body that monitors financial stability, dug into why U.S. stocks have tripled over the past six years. While the gains in the market have indeed been driven by rising corporate earnings, that fact obscures a more troubling truth beneath–sales growth is trailing well behind earnings growth. Companies have higher profit margins (and thus higher stock prices) not because the economy is booming and they are selling more stuff but because they have cut costs, kept salaries flat and not invested in new factories or research and development.

Share prices have also been driven up by low interest rates that have allowed companies to borrow money on the cheap and use it for short-term gain. Corporate debt (not including debt held by banks) has risen from $5.7 trillion in 2006 to $7.4 trillion today. Much of that money has been used for stock buybacks, dividend increases and mergers and acquisitions. The OFR believes that “although this financial engineering has contributed to higher stock prices in the short run, it detracts from opportunities to invest capital to support longer-term organic growth.” As William Lazonick, an economics professor at the University of Massachusetts at Lowell who does research on the topic, puts it, “We’ve moved from a world in which companies retain and reinvest their earnings to one in which they downsize and distribute them.”

Nobody–not Economists, not CEOs and not policymakers–thinks that’s good for real economic growth. Yet the markets stay up because of the dysfunctional feedback loops. Eventually, of course, interest rates will rise, money won’t be cheap anymore, and markets will go back down. None of it will reflect the reality on the ground, for companies or consumers, any more than it did during the boom times. For individual investors, there’s no clever strategy to get around any of this–you simply buy an index fund and hold it as long as you can before moving into T-bills or cash.

But there’s a deeper conversation to be had about how we might fix our system to bridge this gap between markets and reality. There are plenty of ideas out there, from a sliding capital gains tax based on how long you hold a stock to big limits on buybacks and corporate options pay. Any or all of these might help stock prices reflect what they should–the real value of a corporation.

This appears in the April 06, 2015 issue of TIME.
TIME Economy

Don’t Trust the Markets: A Correction Is Coming

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The Fed, despite its recent pronouncements, will trigger a fall in stock prices later this year

Up until yesterday’s Fed meeting, America’s central bankers said they were going to be “patient” about the timing of an interest rate hike, which most experts believe will ultimately result in a significant stock market correction (see my recent column about why). So why did that make markets go up so dramatically yesterday?

Because everything else about the Fed’s communication said “we’re going to be more patient than ever” about when and how to raise rates. The central bank downgraded its forecast on the US economic recovery, saying that the pace of the recovery had “moderated somewhat,” in large part because of the strong dollar.

Why is the dollar strong? Mainly because everyone knows that the easy money monetary policy in the US is coming to an end. (QE is over, and most economists are now predicting a rate hike by September.) Meanwhile, pretty much every other central bank is now easing monetary policy—witness the ECB’s new money dump, which has sent European markets soaring.

What does all this tell us? That markets and the real economy are disconnected in a way that is terrifying. Central banks are, as chief economic advisor to Allianz and former PIMCO CEO Mohamed El-Erian put it to me recently, “the only game in town.” Every time the Fed says it will keep rates low a little longer, the market party goes on. All that means is that there will be more pain, eventually, when the punch bowl gets pulled away.


Who Let the Bears Out?

The end of easy money means a market correction of significant proportions

New skyscrapers tend to correlate with market peaks. Construction of the Empire State and Chrysler buildings marked a top in equities back in the 1920s, just as the completion of the World Trade Center pegged the top in the 1970s, as behavioral economist Peter Atwater recently pointed out to me. So will the current proliferation of luxury skyscrapers correspond to the end of a multiyear bull market in the U.S.? Quite possibly, yes. In the short run, that could complicate the lives of average investors, but at root it really shows how scrambled the world of international finance has become.

Savvy investors everywhere have been chattering for some time about the arrival of a new bear market. Recently, those worries have reached a fever pitch. It’s not the nosebleed buildings that have them spooked but the machinations of the world’s central bankers. Since the financial crisis of 2008, the trillions of dollars they’ve poured into markets in an attempt to buoy the global economy have basically dictated the direction of stocks–up.

No single actor has done more to bolster markets than the U.S.’s Federal Reserve bank. But in October, the Fed ended its $4.5 trillion bond-buying program, and a strengthening U.S. economy means it is mulling an interest-rate hike, probably by September. Higher rates will mean lower stock prices. In Europe, where the European Central Bank just began a similar bond-buying program, the opposite is true: stocks are going up.

What’s amazing is that the real economy in the U.S. is getting stronger (recent payroll numbers were the best since 2006), even as the European economy is plunging into another episode of the telenovela that is its debt crisis. It’s a bizarro world that makes sense only if you try to understand how central banks work. Central bankers pump money into the market when they perceive their home economies as being weak. They pull back when they sense a sustainable recovery is in hand. The end result is a complete divergence between the real economy and the markets.

This problem has been brewing for decades, as loose monetary policy has become the fallback position for governments that don’t want to do the hard work of training a 21st century workforce, paying for new infrastructure or coming up with smarter, less consumption-based means of growth.

Certainly this was the case post-2008, and the results have been mixed. Many will rightly argue that quantitative easing in the U.S. helped the rich more than the poor, since they hold the majority of stocks. But particularly in the early days, it also greased the wheels of a weak recovery that has benefited everyone, even if unequally. It certainly kept unemployment lower than it would have otherwise been. In lieu of more political action to address the root causes of slower growth, central bankers felt they had no choice but to keep the money spigots on. Fed Chair Janet Yellen, a Keynesian, told me as much when she took up her position last year.

For politicians, it’s always easier to let the central bankers of the world keep the sugar high of easy money going rather than tell this or that vested interest group that things are going to be tough for a while. But what happens when the sugar is metabolized? A market correction, no doubt. The only question is how long and how deep.

The ramifications aren’t likely to be pretty. The Bank for International Settlements, a bank for central banks, based in Switzerland, has warned that the coming Fed pullback in the U.S. could have “significant” consequences. “The disconnect today between the markets and the real economy has never been bigger,” explains Mohamed El-Erian, chief economic adviser at Allianz and chairman of President Obama’s Global Development Council, who is working on a book about how central bankers have distorted the market in pursuit of better economic outcomes. “It scares me to think what happens if we reach the end of this policy road and the economic results are disappointing,” he adds. That leaves average consumers with few good options aside from buying and holding an index fund.

Already we’re seeing more market volatility this year than we saw all of last year, as investors begin to jitter. The U.S. markets may not be the prettiest house on the ugly block that is the global economy anymore. Now that European markets have been sprinkled with central-bank fairy dust, look for money to rush there, despite slower real economic growth. Investors aren’t outright panicking–yet. From the world’s penthouses, it can be hard to see what’s happening on the ground.

This appears in the March 30, 2015 issue of TIME.

The Real (and Troubling) Reason Behind Lower Oil Prices

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It isn't supply and demand, as most people believe

I am obsessed with how the top tier of finance has undermined, rather than fueled, the real economy. In part, that’s because of I’m writing a book about the topic, but also because so many market stories I come across seem to support this notion. The other day, I had lunch with Ruchir Sharma, head of emerging markets for Morgan Stanley Investment Management and chief of macroeconomics for the bank, who posited a fascinating idea: the major fall in oil prices since this summer may be about a shift in trading, rather than a change in the fundamental supply and demand equation. Oil, he says, is now a financial asset as much as a commodity.

The conventional wisdom about the fall in oil prices has been that it’s a result of both slower demand in China, which is in the midst of a slowdown and debt crisis, but also the increase in US shale production and the unwillingness of the Saudis to stop pumping so much oil. The Saudis often cut production in periods of slowing demand, but this time around they have not. This is in part because they are quite happy to put pressure on the Iranians, their sectarian rivals who need a much higher oil price to meet their budgets, as well as the Russians, who likewise are on the wrong side of the sectarian conflict in the Middle East via their support for the Syrian regime.

Sharma rightly points out, though, that supply and demand haven’t changed enough to create a 50% plunge in prices. Meanwhile, the price decline began not on the news of slower Chinese growth or Saudi announcements about supply, but last summer when the Fed announced that it planned to stop its quantitative easing program. Sharma and many others believe this program fueled a run up in asset buying in both emerging markets and commodities markets. “Easy money had kept oil prices artificially high for much longer than fundamentals warranted, as Chinese demand and oil supply had started to turn back in 2011, and oil prices have now merely returned to their long-term average,” says Sharma. “The end of the Fed’s quantitative easing has finally pricked the oil bubble.”

If this is the case, the fact that hot money could have such an effect on such a crucial everyday resource is worrisome. And the fact that the Fed’s QE, which was designed to buoy the real economy, has instead had the unintended and perverse effect of inflating asset prices is particularly disturbing. I think that regulatory attention on the financialization of the commodities markets will undoubtedly grow; for more on how it all works, check out this New York Times story on Goldman’s control of the aluminum markets. Amazing stuff.

Correction: The original version of this story misidentified Ruchir Sharma. He is the head of emerging markets for Morgan Stanley Investment Management.

Read next: The U.S. Will Spend $5 Billion on Energy Research in 2015 – Where Is It Going?

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TIME Economy

Why Finance Is Still a Problem

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Elizabeth Renstrom for TIME

Inequality, tepid job growth, lack of innovation are partially the result of finance's warped incentives

Warren Buffett warned investors that bankers were still up to their old tricks in his recent investor letter. Vanguard founder Jack Bogle is writing about how high fee mutual funds are ripping off investors and endangering retirement security. And Fed Chair Janet Yellen is touting new, tougher capital rules for “Too Big to Fail” banks. Despite the recovery and strong jobs numbers last week, the re-regulation of the financial sector isn’t yet finished. But a deeper worry, and one that’s taking center stage amongst academics, is the fact that finance has yet to be re-moored to the real economy. That may be dampening the recovery for many.

A growing slew of research, including several just-published papers, has found that over a multi-decade period, the rise of finance is associated with lower capital investment in the real economy, greater inequality, and the demise of more productive industries. Brandeis International Business School professor Stephen G. Cecchetti and Enisse Kharroubi, a senior economist at the BIS, recently published a paper entitled “Why Does Financial Sector Growth Crowd Out Real Economic Growth?”

The answer: because finance looks for quick growth rather than long-term rewards. And because finance wants to invest in industries like real estate and construction where there are tangible assets to be collateralized, rather than intangible assets like the ideas and intellectual property that typically power more productive sectors like, say, technology, pharmaceuticals, or advanced manufacturing. What’s more, the disproportionate pay of bankers (they still make about three times what their similarly well-educated colleagues in other sectors do, even post crisis) continues to lure talent away from areas that create more and better jobs for the population as a whole. “When I was at MIT many years ago,” says Cecchetti, “everyone wanted to work in cold fusion or recombinant DNA. By the 1990s, nobody wanted to do that.” Solution? “I think we should take some proportion of the smartest people in the room and make sure they don’t go into finance,” says Cecchetti, only half joking.

Part of the problem with the rise of finance is that it encourages the culture of shareholder value over all else. That means CEOs focus more on buoying stock prices rather than making the best long-term decisions. The effects can be seen in the fact that since the 1980s, share buybacks and dividend payments have increased in direct proportion to a decrease in productive capital investment, according to a recent Roosevelt Institute paper entitled “Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment.”

What’s more, says JW Mason, a Roosevelt fellow who authored the paper, the low interest rates that have prevailed particularly since the 2008 crisis have sped up the trend as firms actually borrow money at lower rates to do more buybacks, rather than invest in the real economy. (The later is, by the way, what the Fed’s easy money policy was intended to encourage.) In fact, business investment dropped 20 % since 2008, as almost all borrowing went back to investors in the form of such payments. “It may be that we need to move to a more active control of investments to make sure that useful projects get funded,” says Mason, who says a kind of “World Bank for the US” might be one answer.

All this dovetails with the country’s inequality problem, which is an issue that will be big in the 2016 election cycle. As Wallace Turbeville, a Demos fellow who has done yet another influential paper on financialization points out, both the Republican and Democratic positions on inequality are lacking. Conservatives believe in bootstrapping, and liberals in redistribution of wealth. But if the very structure of our capitalism is designed to reward mainly elites (something Thomas Piketty’s best seller Capital in the 21st Century pointed out so well last year), then no amount of redistribution or hard work can fix the problem.

We need to fix the structure of capitalism itself and, in particular, figure out a way to make it work better for the masses. Turbeville has some of his own ideas about how to do this, including incentivizing long-term share ownership over high-speed trading, and limiting the use of derivatives. I hope that the economic debate in the primary season will be filled with many more.

Correction: The original version of this story misstated the surname of Brandeis International Business School professor Stephen G. Cecchetti.

TIME Economy

Hard Math in the New Economy

Rana Foroohar is TIME's assistant managing editor in charge of economics and business.

Tech is disrupting traditional work. Is that really a bad thing?

Technology has always been a net job creator. So why do so many of us feel that the robots (or algorithms) are about to take our jobs? A recent Kaiser Family Foundation poll of unemployed Americans ages 25 to 54 found that 35% believed that they’d been displaced by technology. It’s true that software can do more work that human beings used to do. But it’s also true that Silicon Valley hasn’t dealt particularly well with growing fears about tech-related job displacement, at least from a public relations standpoint.

The truth is that technology has long served as an easy target for employment alarmists–in no small part because innovators tend to tout new efficiencies and cost savings foremost. But as a recent Brookings Institution analysis put it, “Historically, technological progress has created winners and losers, but over the long run, [it] has tended to create more jobs than it has destroyed.”

If you look at the shift from an agrarian to an industrial society, that’s certainly true. From 1900 to 2000, the proportion of the workforce working on farms fell from 41% to 2%, yet agricultural output increased and farmers eventually found jobs in factories or, later, in cubicles. That’s not to say that periods of technological change aren’t fraught. There’s a reason the textile artisans who came to be known as Luddites started smashing knitting machines in 19th century England.

Nobody has started smashing their Laptops or iPads yet. But it is disturbing to see how unevenly the gains from the past 20 years of technological innovation have been shared. Many economists associate the middle class’s shrinking partly with the fact that technology is displacing people. Increasingly, there are jobs for Ph.D.s and hands-on laborers like, say, home health care aides, but more and more of what’s in between can be automated. Self-driving cars are coming for chauffeurs; drones threaten delivery drivers. A recent National Bureau of Economic Research paper co-written by economist Jeffrey Sachs hypothesized that software developers themselves might someday be replaced by the very programs they create.

There is a strong counterargument that the jobs and value technology create just aren’t being counted properly. “GDP was designed to measure the output of 20th century industrial nation-states making stuff, not a 21st century economy generating bytes and ideas,” says Zachary Karabell, whose book The Leading Indicators: A Short History of the Numbers That Rule Our World examines what our current system does and doesn’t tally.

Academics like the Massachusetts Institute of Technology’s Erik Brynjolfsson, who believes we vastly underestimate the productivity created by the “free goods of the Internet,” would agree, as would Silicon Valley entrepreneurs like Airbnb CEO Brian Chesky. His company may have 30 million users and only 1,600 employees, but Chesky says it creates many more “21st century jobs” by helping generate extra income for hosts who monetize their homes and for local businesses and such service providers as cleaners who benefit from the influx of vacationers. For New York City alone, Chesky puts the value of that additional income at $768 million annually, which the company claims supports 6,600 jobs. Of course, those are “jobs” without the health care, 401(k) or other benefits that a traditional position might provide.

Which underscores a disturbing truth about the new economy: it’s all on you. People who are smart, well educated and entrepreneurial may well do better in this paradigm. But what about those who aren’t as well positioned or at least need help in tooling up?

The obvious answer is for government to provide more help through a reformed educational system, workforce training and a social safety net to pick up slack. That’s what I consistently hear tech titans and other CEOs calling for. The hitch is that they are calling for it even as they pay a smaller share of the tax pie to fund it all. (About a third of all the corporate profit sitting in overseas bank accounts is from technology-driven firms.) Certainly some companies are making big private contributions to educational reform; Google, Microsoft and IBM are prime examples. But more will be needed.

For now, the power divide between the public and private sectors is only growing. The public sector holds most of the world’s debt, as well as responsibility for the welfare of those who are being “disrupted.” Big Tech has the profits but could stand to do some creative thinking about how better to share–or at least account for–the rewards of innovation. Otherwise it risks breeding a whole new generation of Luddites.

This appears in the March 16, 2015 issue of TIME.

TIME Ideas hosts the world's leading voices, providing commentary and expertise on the most compelling events in news, society, and culture. We welcome outside contributions. To submit a piece, email ideas@time.com.

TIME Economy

The Real Meaning of $9 an Hour

Walmart’s decision on Feb. 19 to raise its base wage to $9 an hour, $1.75 higher than the federal minimum, has been heralded as a major victory for American labor. Wall Street punished the world’s largest retailer for the pay hike–which will cost the firm $1 billion this fiscal year–by driving down its shares. But labor economists and liberals lauded the raise as a new wave of “Fordism,” referring to Henry Ford’s historic 1914 decision to double wages in his factories, which not only boosted productivity and reduced turnover but also created more customers for his company’s products.

Walmart’s move is seen by some as a sea change for the retail sector. “Walmart sets the standard, and the fact that they’ve kept wages so low has made it hard for others to raise them,” explains Isabel Sawhill, co-director of the Center on Children and Families at the Brookings Institution. Now it’s likely that pay for other low-income workers will rise, not just in retail but also in other sectors like home health care, child care and fast food, all of which compete for the same workers as Walmart.

The question is, how much will it matter? Labor’s share of the economic pie has been decreasing since the 1970s, thanks to globalization, which has outsourced low-wage jobs (and technology, which has destroyed them outright); the shrinking of unions; and pressure from Wall Street to reduce costs, which turbocharged all these trends. The corporate share, meanwhile, is at record highs. That means Walmart’s move to $9 an hour won’t make much difference in macroeconomic terms. The $1 billion it will effectively put in the hands of 40% of its 1.3 million U.S. employees is a tiny fraction of our $16 trillion economy. Damon Silvers, the policy director of the AFL-CIO, estimates that even if all low-wage employers followed Walmart’s lead, it wouldn’t move the needle on labor’s share by even a single percentage point. “That’s not to say that the Walmart workers’ victory isn’t an important step forward for low-wage workers,” he says. “But it also shows what a small piece of the pie they’ve been getting.”

Indeed, the Walmart workers who have spent much of the past year in parking lots with bullhorns were asking for $15 an hour and better schedules. “When I started, I saw how many of us were working for one of the richest companies in the world and yet we had to be on public assistance,” says Kelly Sallee, 22, who has worked for Walmart for eight months and took part in wage protests in Dayton, Ohio. Despite the pay increase, employees like Sallee, who says she’d like to work full time but can’t get enough hours, are still struggling for improvements in scheduling, an important labor-rights issue. Retailers across the country use software to optimize scheduling around store traffic. This often means less notice given for when workers must report to their jobs and erratic cuts in some of their hours, which labor activists believe may also be intended to decrease the number of workers on full-time benefits. Walmart denies this and says it would prefer more full-time workers to multiple part-timers. The company also says that the $9 it will pay is better than the $7 and change paid by many other retailers, even some unionized ones, and that it gives more notice of shift changes than many others. It says that workers can ask for more hours via Walmart’s intranet system and that 1 million hours a week regularly go unclaimed.

But the fact that Walmart workers, who aren’t unionized in the U.S., got anything at all shows the PR pressure that companies like it are coming under as economic inequality gains clout as a political issue. Twenty-nine states have raised the minimum wage, and presidential candidates from both parties are expected to wrestle with the challenge for the next 18 months. Whether or not Walmart’s top brass, a conservative bunch, has experienced an ideological shift is not the point. That it is concerned about turnover costs as a better economy gives laborers more options for where to work is most significant.

An extra couple bucks an hour will certainly help low-wage workers, and they’ll be more likely to spend it than the rich, meaning it will drive more economic growth. It will not be a net job destroyer, as some believe. The nonpartisan Congressional Budget Office found that while a $9 minimum wage could put from zero to 500,000 low-end jobs at risk as companies try to limit staffing, it would also lift 1 million people out of poverty and increase earnings for 16.5 million workers. As Sawhill puts it, “That’s not quite a free lunch, but it’s pretty cheap.” That’s a reason for Congress to raise the federal minimum wage. But even if it doesn’t, Walmart workers have proved they can move the most powerful retailer in the world to change. That means they, and others, can do it again. And that, more than anything else, may be the real victory.

This appears in the March 09, 2015 issue of TIME.
TIME Economy

What’s Really to Blame for Weak Economic Growth

The George Washington statue stands covered in snow near the New York Stock Exchange (NYSE) in New York, U.S. Wind-driven snow whipped through New Yorks streets and piled up in Boston as a fast-moving storm brought near-blizzard conditions to parts of the Northeast, closing roads, grounding flights and shutting schools.
Jin Lee—Bloomberg via Getty Images The George Washington statue stands covered in snow near the New York Stock Exchange

Finance is a cause, not a symptom, of weaker economic growth

After years of hardship, America’s middle class has gotten some positive news in the last few months. The country’s economic recovery is gaining steam, consumer spending is starting to tick up (it grew at more than 4 % last quarter), and even wages have started to improve slightly. This has understandably led some economists and analysts to conclude that the shrinking middle phenomenon is over.

At the risk of being a Cassandra, I’d argue that the factors that are pushing the recovery and working in the favor of the middle class right now—lower oil prices, a stronger dollar, and the end of quantitative easing—are cyclical rather than structural. (QE, Ruchir Sharma rightly points out in The Wall Street Journal, actually increased inequality by boosting the share-owning class more than anyone else.) That means the slight positive trends can change—and eventually, they will.

The piece of economic data I’m most interested in right now is actually a new report from Wallace Turbeville, a former Goldman Sachs banker and a senior fellow at think tank Demos, which looks at the effect of financialization on economic growth and the fate of the working and middle class. Financialization, a topic which I’m admitted biased toward since I’m writing a book about it, is the way in which the markets have come to dominate the economy, rather than serving them.

This includes everything from the size of the financial sector (still at record highs, even after the financial crisis and bailouts), to the way in which the financial markets dictate the moves of non-financial businesses (think “activist” investors and the pressure around quarterly results). The rise of finance since the 1980s has coincided with both the shrinking paycheck of most workers and a lower number of business start-ups and growth-creating innovation.

This topic has been buzzing in academic circles for years, but Turberville, who is aces at distilling complex economic data in a way that the general public can understand, goes some way toward illustrating how the economic and political strength of the financial sector, and financially driven capitalism, has created a weaker than normal recovery. (Indeed, it’s the weakest of the post war era.) His work explains how financialization is the chief underlying force that is keeping growth and wages disproportionately low–offsetting much of the effects of monetary policy as well as any of the temporary boosts to the economy like lower oil or a stronger dollar.

I think this research and what it implies—that finance is a cause, not a symptom of weaker economic growth—is going to have a big impact on the 2016 election discussion. For starters, if you believe that the financial sector and non-productive financial activities on the part of regular businesses—like the $2 trillion overseas cash hoarding we’ve heard so much about—is a cause of economic stagnation, rather than a symptom, that has profound implications for policy.

For example, as Turberville points out, banks and policy makers dealt with the financial crisis by tightening standards on average borrowers (people like you and me, who may still find it tough to get mortgages or refinance). While there were certainly some folks who shouldn’t have been getting loans for houses, keeping the spigots tight on average borrowers, which most economists agree was and is a key reason that the middle class suffered disproportionately in the crisis and Great Recession, doesn’t address the larger issue of the financial sector using capital mainly to enrich itself, via trading and other financial maneuvers, rather than lending to the real economy.

Former British policy maker and banking regular Adair Turner famously said once that he believed only about 15 % of the money that followed through the financial sector went back into the real economy to enrich average people. The rest of it merely stayed at the top, making the rich richer, and slowing economic growth. This Demos paper provides some strong evidence that despite the cyclical improvements in the economy, we’ve still got some serious underlying dysfunction in our economy that is creating an hourglass shaped world in which the fruits of the recovery aren’t being shared equally, and that inequality itself stymies growth.

TIME Economy

Starbucks For America

Ian Allen for TIME

Howard Schultz is transforming his company. Changing the country is going to be harder

Howard Schultz isn’t afraid of his feelings. Or anybody else’s, for that matter.

The 61-year-old Starbucks CEO doesn’t mind tears or hugs or displays of emotion of any kind. This is front and center on an icy January afternoon in New York City, where Schultz is leading a forum on race. Shocked by recent police shootings and unrest in Ferguson, Mo., New York City and Oakland, Calif., he decided to hold open meetings in five cities where Starbucks employees from top managers to entry-level baristas could speak frankly about their experiences with racism.

A little more than 40% of the company’s baristas are minorities, and the audience of 400 or so at Cooper Union’s auditorium reflects that. Schultz has just come from a meeting with New York City police commissioner William Bratton in which the two discussed ways the company could help ease tensions. Like a candidate holding forth during a televised town hall, Schultz is speaking from a spot on the floor near the crowd. “People have told me we shouldn’t touch this issue, that we might stir things up, upset the shareholders. I don’t agree with that,” he says. “Conversations are being ignored because people are afraid to touch the issue. But if I ignore this and just keep ringing the register, then I become part of the problem. So here we are. Let’s talk.”

Pretty soon, the floodgates are open. The microphone is passed around, and dozens of partners, as Starbucks employees are called, begin sharing their stories. Some are crying, others angry. A young Senegalese immigrant, Tafsir Mbodje, a district manager who runs the Grand Central store among others, points out the slow police-response times in his former neighborhood, East New York. “I feel like we are at a tipping point in this country,” Mbodje says. “And it’s only going to take one more thing, one more event, to make things boil over.” Schultz takes the microphone. “I was born in East New York, and I agree with you. We are at a tipping point. There’s a lack of leadership in Washington, in government, and so it has to come from us.”

The forum is quintessential Schultz. He is at his best with his people, talking about issues that other CEOs would rather not come up in mixed company. In recent years, Schultz has taken on student debt, health care, veterans’ rights, youth unemployment and gun violence. All this do-goodery can be hard to live up to 24/7. A progressive image can sting if it appears hypocritical, as it did in 2014 when a New York Times story chronicled how Starbucks’ staff-scheduling software could wreak havoc on the lives of workers with kids. (Schultz says the problem has since been fixed.) And though investors have cheered Starbucks’ recent performance–on Jan. 22, the Seattle-headquartered company said sales in the most recent quarter had grown by 13% year over year, to $4.8 billion–a CEO’s personal passions can irk investors when times turn tough.

Lately Schultz has been focused on one intractable problem in particular that will take more than a few feel-good forums to tackle: the future of the U.S. economy. The Great Recession and the recovery that followed have warped the economic landscape. What has emerged is an hourglass-shaped comeback with growth at the high and low ends and shrinking in the middle. Wealthy households have made huge strides while middle-income Americans struggle, reshaping businesses from housing and cars to groceries and clothing. Labor Department data show that wages for the vast majority of American workers have stagnated over the past decade. The U.S. is increasingly a nation of latte drinkers and latte makers, with very little room in between. Schultz, of course, depends on both.

His plan to address this, he tells TIME, could change your local Starbucks as you know it. Those changes also reflect the challenges facing the country as a whole. “Whether you’re a Republican or a Democrat,” he recently said, “we can all know and recognize one thing: the country is not going in the right direction.” That’s the kind of talk that had some, including Schultz’s powerful pals, wondering if these are the musings of an outspoken billionaire flirting with the idea of taking a run at the world’s most powerful job.


A few weeks back, when Starbucks released its impressive quarterly numbers, Schultz got up in front of a bunch of Wall Street analysts and gave them the bad news. “There is no company you can point to that is as dependent as we are on human behavior, the human condition and the people that wear the green apron,” he said. And unfortunately that condition is, as he put it, “fragile.” Schultz was referring to consumer sentiment, which, while improving, is still volatile. Spending can collapse at a moment’s notice, just as it did during the Ferguson riots, when coffee sales nationwide suddenly dipped as consumers hunkered down at home rather than going out and spending.

Schultz is acutely aware of this because four times a day, he gets what may be the most up-to-date consumer-confidence indicator in America–Starbucks’ coffee-sales figures. With nearly 12,000 stores nationwide, “we have a lens on almost every community in America,” he says. “At 4:30 in the morning, I wake up and see the numbers of basically every store from yesterday.” Those numbers give a picture that is very different from and much more sensitive than quarterly GDP figures. Over the past few years, says Schultz, they’ve pointed to a “fractured level of trust and confidence” that he attributes in large part to a sense that government is no longer functional and that no one is looking out for the welfare of the middle and working classes.

Sales will rise and fall with the national mood, tanking quickly during events like the New York City police protests–or the 2013 government shutdown, just one of the recent moments when Schultz has worried about the effects of partisan politics on the economy. “I called the White House after the government shutdown and shared with them [figures showing] that leading into the shutdown and for weeks afterward, we saw a significant drop in consumer spending.” He spoke to people “at the very highest level on both sides of the aisle” to stress his feeling that this effect would be “lingering” and would result in a more skittish consumer. “And that’s exactly what’s happened,” he says.

Starbucks–whose baristas, at Schultz’s suggestion, wrote come together on coffee cups in protest over the shutdown–already had a reputation at that point as a progressive company, having been one of the first retailers in the country to offer affordable, comprehensive health care to full-time and eligible part-time employees and their families, as well as a stock-grant program (Bean Stock) for all. And there have also been big pushes in areas like workforce training (the company and the Schultz Family Foundation together have trained nearly 700 disadvantaged young people for jobs in retail or customer service), hiring and training of returning veterans (Starbucks has pledged to employ 10,000), student debt and access to education (the company has promised to help pay for employees to get their bachelor’s degree, an investment that will likely cost Starbucks tens of millions of dollars).

Schultz says he is deeply invested in these ideas not only because making the company a preferred employer helps keep turnover costs lower and service quality higher than the industry average but also because he believes corporations have a duty to help people realize the American Dream. “I think the private sector simply has to take a larger role than they have in the past. Our responsibility goes beyond the P&L and our stock price. We have to take care of people in the communities that we serve. If half the country or at least a third of the country doesn’t have the same opportunities as the rest going forward, then the country won’t survive. That’s not socialism,” says Schultz. To him, it’s practical reality.

Schultz believes that keeping the economy viable will also require major changes in corporate business models, Starbucks’ included. And that’s where customers will begin to notice some changes. Just as fashion brands have haute couture and mass-market lines, Starbucks this year will open the first of a series of luxury Reserve stores, where customers can get a more rarefied and expensive assortment of coffee. (Some may also experiment with selling wine.) Expect many more specialized formats designed for specific places, like express stores coming to New York City or mobile trucks currently on college campuses. Over the next five years, Schultz will be busy transforming the Starbucks experience, in large part by experimenting with ways to draw in ever-more-fickle consumers.

In part, that will involve taking seriously the crowded space for cheaper coffee, a phenomenon that along with the financial crisis helped lead to a steep downturn in Starbucks’ fortunes in 2008. Starbucks will have to compete more directly not only with McDonald’s and Dunkin’ Donuts but also with budget outfits like 7-Eleven. (When even Taco Bell is advertising its coffee, you know things are getting tough.) You will start to see the mermaid logo near places like your local bowling alley. The firm that built its image on an “emotional” connection to coffee that allowed for personal indulgences like $5 mocha Frappuccinos is going to have to find ways to compete with those that sling bare-bones $1 coffee–and a lot of it. (Starbucks hasn’t decided yet how the menu might change.) The company is approaching this in a characteristically cool way–building outlets from used cargo containers at highway exits, for example–but it’s not going to be easy to make one brand mean two things to different customers.

More important, this change of course puts the company in an awkward position. To continue to grow, it must adapt to the economic landscape, making a play for high-end consumers with disposable income while also tailoring outlets and products to lower-end consumers who have less to spend. But doing this means Schultz is implicitly accepting a truth that he has been rallying against for years. That leaves Starbucks aggressively changing its business model to make the most of a country in which the middle class is shrinking while its outspoken CEO loudly cries out against the forces that shrink it. The future of Starbucks, like the economy itself, has a split personality.


This divide is not unfamiliar to Schultz. he grew up the watchful, working-class child of a depressed, blue collar father. The elder Schultz, a military veteran without health care who was driving a diaper truck in the days before disposables were ubiquitous, fell on the ice when Howard was little and was let go with no benefits or pay. He never recovered, physically or mentally. With Schultz’s dad couchbound and unable to work, the family struggled with poverty in the housing projects of Canarsie, Brooklyn. “I saw my father, who was unfortunately very bitter about his own life, not ever having the self-respect that he thought he deserved, because he was an uneducated blue collar worker,” says Schultz. “Consciously or unconsciously, I think one of the things I was trying to do was build the kind of company my dad never got to work for.”

That focus on the working poor is something that sets Schultz apart from many in the 0.001% of which he is now a part. (Forbes estimates his net worth at some $2.4 billion; famous friends include JPMorgan Chase CEO Jamie Dimon and Oprah.) His wife Sheri, an equally kinetic and emotive blonde who looks a little like actress Ellen Barkin, helps run the family foundation. She remembers humility and appreciation for people as the qualities that initially drew her to Schultz when the two met in a Hamptons house share 36 years ago. “You know how they say you can find out about a person when you’re in a restaurant and you see how they treat someone who helps you? He would be that guy who before he left would go to the boss and say how great the person was that served our dinner,” says Sheri. “That’s Howard.”

One Friday afternoon at the Camp Pendleton Marine base near San Diego, Schultz sits signing copies of For Love of Country, a book he co-wrote with Washington Post senior correspondent Rajiv Chandrasekaran about the struggles of returning veterans. A hundred or so people have lined up for copies, and Schultz is quietly scribbling his signature until a middle-aged man from Sunset Park, Brooklyn, strikes up a conversation. Within seconds the two are backslapping and joking about who came from the tougher neighborhood. “When you say you went to Canarsie High School, you get a whole new level of street cred!” boasts Schultz. He waves over his genteel-looking public-affairs director, Vivek Varma. “Hey, how long do you think Viv would last in the Bayview projects?” Schultz asks his new buddy. “With that watch?” the man fires back. “How fast can you run?” He and Schultz both double over laughing.

Schultz may be of the people, but he’s no saint. He’s more sensitive than most executives to criticism and tough questions. So much so that he has a tell: when he’s on the defensive, his eyes open wider than normal. And like many business leaders from hardscrabble backgrounds, he can be a control freak. Top staffers say multiple 5 a.m. emails from him aren’t unusual. Is that tough? I ask one lieutenant. “Only if you are a normal person who gets started at 8 a.m.,” he responds, a little weary. Schultz also has a tendency to parachute into situations, pre-empting members of his staff who are trying to do their jobs. He says he needs to combat his tendency to “override the people who are responsible. [It’s] not healthy for the organization.” One rare rich-guy move, Schultz’s purchase of the Seattle SuperSonics in 2001, ended with a very unpopular sale that relocated the team to Oklahoma City; Schultz was frustrated by the experience in part because he didn’t get as much control as he would have liked.

Schultz continues to push generous benefit packages for staff, despite protests from the Street. In 2008, when bankers wanted him to cut health care to make his margins, he refused. “We found that 70% of the people working for Starbucks did not have a college education,” Schultz says, “and a large percentage of them had started and stopped.” To solve that, he partnered with Arizona State University, which has an extensive online curriculum, to allow Starbucks employees to go to school on their own time while continuing to work. So far, 1,500 employees have taken up the offer (Starbucks says job applications have jumped too as a result), giving the notion of online education a boost in legitimacy and earning Schultz praise from both liberals and conservatives.

Grover Norquist, the right-wing tax activist, sees Starbucks as a model for a kind of business federalism in which the private sector does things better and faster than government. “Howard isn’t saying, Hey, I’ll give you a check. He’s saying, I want your skills, [at the same time] that he’s changing the cost of education by revolutionizing education itself. He’s backing into the reform of public education,” says Norquist, who also believes Starbucks’ lead on the veteran-hiring issue could displace entire departments of the federal government. “More people live close by a Starbucks than a VA office.”


Inevitably, all the talk about a leadership void in Washington has led people to wonder whether Schultz might be privately positioning himself for public office. (He is a Democrat.) There is, after all, a rich tradition of wealthy businesspeople pushing political agendas, from Edward Filene, who started Filene’s Basement before helping develop community credit unions and pass the first workmen’s-comp law, to former eBay CEO Meg Whitman, who unsuccessfully ran for governor of California five years ago. People close to Schultz, like entertainment mogul David Geffen, have suggested he think big. “I first told Howard he should run back in 2008,” Geffen says. “We were having a very intense conversation about things that were happening in the country, and Howard had a strong point of view about various things,” like, for example, the bank bailouts. “We both felt there was a lot of corruption in government and a lack of conviction to put things right.”

Bill Etkin, a financier and lawyer who is a close friend of Schultz’s as well as a consultant for Starbucks, says the CEO did think seriously at one point about entering the political arena. Schultz and his wife hosted a dinner for Michael Bloomberg a few years back when the former New York City mayor was considering a run for President. The two discussed the challenges of moving from the business world to politics. Etkin says Schultz ultimately feels he can do more for the public good from his current perch than he could in Washington. Mellody Hobson, president of the $10 billion asset-management firm Ariel Investments and a Starbucks board member as well as an Obama campaign supporter, says, “Howard is a maverick, and mavericks don’t do well inside big institutional structures.” Norquist puts it more bluntly: “‘You should run for office’ is what people in this country say to you when they mean ‘I like your ideas. I wish people in Washington thought like you did.’ That’s what Ralph Nader’s friends said to him, and when he ran, they screamed at it and said, ‘Hey, you are funneling money away from the mainstream of the party!'”

For his part, Schultz insists he’s not interested in running for office at the moment and has neither the temperament to make the compromises necessary to embark on a Democratic political career nor the desire to be a third-party candidate. “I don’t think that is a solution. I don’t think it ends well.” There is also the baggage that every successful businessman turned politico has to carry in terms of translating his successes–and his failures–in one realm to another. In 2012, for example, Starbucks ran into PR trouble in the U.K. after revelations that it had paid only minimal corporation taxes on many hundreds of millions of dollars in sales. The company, which had been domiciling in the Netherlands, as many large companies do, says it complied with all tax laws. Starbucks has since voluntarily paid more, and it has moved its European headquarters to the U.K. Still, the episode shows how difficult it would be to balance running a multinational company with running a progressive political campaign. For now, Schultz says, he’s content to “see what Hillary does.”

Whatever his future ambitions, Schultz is caffeinated and eager to do bold things both for his business and for the country at large. Wherever he goes, he pops into Starbucks stores, sometimes recognized, often not. “Hey, how is that Pumpkin Spice Latte doing?” he asks the somewhat shocked manager of a store in San Diego, where he has made a surprise visit for his fifth Sumatra of the day between meetings with veterans’ groups. Baristas scramble to fill the order, looking a little awestruck. “Maybe we should move the holiday display cards up a few inches?” Schultz offers.

Schultz is busy mapping Starbucks’ future. The company recently announced the hiring of a new No. 2, 16-year Microsoft veteran Kevin Johnson, to help lead a push into mobile payments. Through its smartphone app, Starbucks already does more of those per week than any other retailer, and Schultz has visions of competing with the likes of Apple Pay. In Seattle, Schultz just opened a flagship Starbucks Reserve Roastery and Tasting Room, a Willy Wonka–esque coffee fantasia where customers can watch every part of the coffeemaking process, from bean roasting to foammaking. A hundred high-end Reserve stores are coming in the next five years to cities including Chicago, Los Angeles, New York, San Francisco and Washington. And Starbucks says customers in some cities will be able to get their caffeine fix delivered to their door by the end of 2015.

There will be challenges along the way. Aside from the bargain-basement competitors, Schultz will have to keep his eye on a raft of high-end bespoke coffee chains trying to re-create Starbucks’ early formula, including Blue Bottle, based in Oakland, Calif. Other enthusiastically unveiled initiatives, like a push into food, have been hit or miss. Schultz’s founder’s passions still burn, but he has a hard road ahead in the split economy, and the future of Starbucks after him is unclear at best.

On the policy front, the company is planning to dramatically ramp up the number of out-of-work young people, veterans and other struggling groups that get workforce training through Starbucks. On Feb. 9 in L.A., Schultz is holding the company’s first open forum on racism with non-Starbucks participants. Meanwhile, the early-morning emails with the next big idea–to staffers, friends, his wife, other CEOs–are unlikely to stop coming anytime soon. “I like to take big swings,” says Schultz, smiling and chugging yet another Sumatra. “Maybe it’s all the coffee.”

This appears in the February 16, 2015 issue of TIME.
TIME Davos

Down and Out in Davos

Why the world’s powerful are worried about 2015

It’s a perennial question: What is the World Economic Forum (WEF) actually good for? The annual confab of the world’s rich and powerful in Davos, Switzerland, has evolved significantly in the past few decades, from a gathering of hardcore economists and financiers to a broader forum for the discussion of ideas ranging from the role of women in the workplace to the future of the Internet. In my opinion, it’s still the best place on earth to get a sense of what global decisionmakers will be thinking about in the year ahead. I made my way around the Magic Mountain listening to bankers, executives, policymakers and world leaders, and here’s what I found.

Tech Brings Bad With Good

Digital Disrupters and Web Pioneers–Google executive Chairman Eric Schmidt, Yahoo CEO Marissa Mayer and Facebook COO Sheryl Sandberg among them–were out in force as always, extolling the virtues of concepts like the “Internet of things,” which could create entirely new markets. But average people don’t necessarily share their enthusiasm for, and abiding faith in, tech. The Edelman Trust Barometer report, a 27-country survey measuring confidence in the public and private sectors that was released during the conference, found that the majority of the world’s consumers think technological change is moving too fast for them. By a margin of 2 to 1, people don’t believe that governments or businesses are thinking enough about the broad societal impact of developments like social media, digital security, genetically modified foods and fracking. Technology for technology’s sake, most people feel, is not a good thing.

That, in part, may be because the gains made possible by technology over the past decade or so have been unevenly shared. A WEF white paper prepared by the Swiss bank UBS found that sectors boosted by new technologies, such as finance and manufacturing, “have delivered a large share of U.S. economic growth without adding significant numbers of new jobs.” Smarter software and the advent of such innovations as 3-D printing are making some people very wealthy. But technological advances have done comparatively little to replace the middle-class jobs lost over the past couple of decades.

How to explain the divide? Technologists like MIT’s Andrew McAfee, who made waves at Davos last year with a book he co-wrote, Race Against the Machine, would argue that the scope of the digital revolution is so massive that it will destroy more jobs before it starts creating them and that the broader growth-enhancing effects of technology will simply take longer to be felt. As the UBS paper notes, it took around 50 years for the benefits of electricity to completely filter through the economy. Still, for a civilization that reflexively looks to technology to deliver us from seemingly unsolvable predicaments, this is a worrisome trend.

Global Growth May Be in Peril

We need that broader tech boom to goose productivity. Globally, productivity grew at a good clip over the past half-century, rising 1.7% a year. But as countries become more developed, productivity growth slows. One of the most sobering presentations, given by the consulting giant McKinsey, made the point that when you combine slower productivity with a dramatic decrease in the global birth rate, you get economic growth that could be much lower over the next 50 years than it has been in the past 50.

Economic growth is basically a function of the number of workers and their productivity. The former is falling sharply as countries get richer and women have fewer children, and the latter is more or less stagnant. “It’s as if we’ve been flying a plane on two engines, and one of them is about to go out,” says James Manyika, head of the McKinsey Global Institute. If current trends continue, McKinsey projects that global growth will slow to about 2.1% a year, even as more people than ever have expectations of a middle-class life. Not a great formula for social stability.

Women and Children First

People can keep praying that technology will produce more middle-class jobs, but there is one proven solution for boosting economic growth: putting more women to work. The picture of gender parity from Davos is never great; this year, the meeting had a record 17% female participation, up from 9% in the early 2000s. One WEF study found that at the current rate of change, it would take women 81 more years to reach economic equality with men.

Ironically, this seems to have created a cottage industry in gender-parity consulting. Employees of both sexes from firms like Mercer and Ernst & Young were at Davos hawking strategies about how to promote women. My advice: think less about leaning in and more about how to help families create support structures that allow more women to work. Warren Buffett once suggested to me that the U.S. government should offer subsidized child care, allowing caregivers (mostly women) to earn a better wage while freeing women who are higher up the educational food chain to take bigger jobs. It remains one of the best policy proposals I’ve ever heard.

Plenty of Band-Aids, Not Many Cures

Of course, that would require action from politicians, something that everyone agrees is in short supply. The divide between the fortunes of global markets (which have remained surprisingly buoyant) and national economies (which are sluggish in many parts of the world) was a big topic yet again. In the middle of the WEF meeting, the European Central Bank (ECB) launched its version of quantitative easing, a $1.3 trillion bond-buying program of the type that the U.S. Federal Reserve–which bought some $4 trillion in assets over the past few years–has only just reined in. It is an effort to help Europe avert another recession, and markets responded instantly, with European stocks rising, bond yields falling and the euro weakening, which should help exports.

While many at Davos were grateful for the uptick in their portfolios, some high-profile financiers fretted that the ECB’s move comes with a downside that will thwart a lasting solution to the European debt crisis. As hedge funder Paul Singer put it to me, “The QE program takes the pressure off European leaders to take the fiscal, tax, regulatory, trade, education and other steps necessary to generate real sustainable growth. [ECB president] Mario Draghi is an enabler, because the money printing enables the Presidents and Prime Ministers to avoid making real structural reforms.”

Polarized politics on both sides of the Atlantic has made it hard for governments to make the sorts of moves that create real growth. (The recent Greek elections won’t change much there.) So central bankers have kept the easy money flowing to give countries more time. But the emerging-market crises of the 1980s and ’90s teach us that printing money isn’t a substitute for fixing structural problems. If you do one without the other, the market will punish you viciously later on.

And all that easy money has exacerbated the growth of inequality globally, since most of it has gone to pumping up stocks, which are mainly held by the top 25% of the population. Wages remain stagnant and middle-class jobs elusive. That divide, which reflects the one between Davos and everywhere else, is what we’ll be grappling with in the year ahead.

This appears in the February 09, 2015 issue of TIME.

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