The K-Shaped Economy

Analysts and economists have increasingly described the U.S. economy as being in a K-shaped expansion. And what they mean by that is that the economy is increasingly bifurcated.

If you think about the shape of the letter K, the upward slope, the part of the economy that is doing really well, is essentially people who are high on the income spectrum, and especially people who are invested in financial markets.

Markets have done extraordinarily well lately.

The other side of the K, though, the downward-sloping part, is people at the lower end of the income distribution, who in most cases have not been invested in financial markets. And we are seeing in the data increasing signs of strain among that cohort.

Just as one example, delinquency rates on car loans have risen over the course of the last several months and are now at the highest they’ve been this cycle.

We see signs of the benefit of financial market performance at the top end of the spectrum as well. More than 50% of the consumption in our economy today is being driven by the top 10% of income earners.

So I think that the K shape is a nice way to think about what’s going on in the economy. The only pushback I would have is that this is somehow new. This isn’t new. This has been going on for years, perhaps even decades.

Just to put something a little more tangible around the magnitude of the gap: in economics, we use a concept called “Gini coefficient” to measure the gap between the top and the bottom of the income distribution. The U.S.’s Gini coefficient right now is the highest among the OECD countries, and it is closer to what we’re used to seeing in emerging markets.

Now, this isn’t a precise measure, and we don't want to go too far down the path of micromanaging what it is or what it means.

But in a general sense, I think it illustrates the point that what’s going on here is atypical. This is a lot higher than it usually has been for the U.S., and again, a lot higher than it is for the countries we tend to think of as our peers.

Now, the other topic that is front of mind for investors and for market participants has been artificial intelligence and the boom in AI. That points in the exact same direction.

AI and the benefits of AI are being reaped largely by those who are invested in financial markets, by the owners of capital, if you will. Corporate profit margins are rising.

The other side of that, of course, is that the way in which artificial intelligence is boosting productivity is largely by punishing labor. We have seen the rate of job creation slow quite dramatically this year.

Now, not all of that is due to AI, but I think it’s reasonable to assume that a lot of it is. Unemployment has risen across the board, but it has risen most profoundly for young workers—those whose occupations are most vulnerable to being replaced by artificial intelligence.

There isn’t a whole lot that the Fed or that other policymakers can do about this. The Fed’s mandate is to pursue price stability and full employment. It isn’t to worry about the allocation of gains within the economy, and at an aggregate level, the economy looks OK.

At the same time, inflation has been sticky. This is what happens when you put tariffs in place on an economy that is performing relatively well.

It isn’t just tariffs, of course. The cost of living concerns that are being felt across the income spectrum manifest themselves in the data as inflation.

And that means that, while we think the Fed will continue cutting rates, we think that they are going to be relatively cautious in doing so.

Of course, cutting rates itself accentuates the gap in the K, if you will, because it is likely to boost financial markets even further.

So when we look ahead, what we see is that this is a trend that has legs. The gap between the haves and the have-nots is likely to widen going forward.