Guest Post: Wealth Inequality In America, Understanding The Source

Submitted by Arkady of The Right Condition

Wealth Inequality In America, Understanding The Source

With the OWS movement leaving many Americans confused as to whether they should support or stay away, one thing is for certain, Americans are aware of a certain truth that is happening in our country.  We have a certain combination of events that is leaving many people struggling and asking very good questions.

The truth is this; We have structurally high unemployment, salaries are stagnant, debt burdens are rising, costs for education, health and energy are on the rise and we are increasingly overwhelmed with clear and present danger coming from every corner of the earth.

To make matters worse the ruling elite of this country and the very wealthy are continuing to benefit while the remainder of the population struggles.  This is the appeal of the OWS movement despite the fact that the members making up the movement are advocating entirely unappealing solutions in the form of wealth distribution, punishing success and other hard left ideologies.

Of course in a country where American Idol and the Jersey Shore are better known than who currently runs the Federal Reserve it is hardly a wonder that cries for Socialism just sound appealing.  To further exacerbate the overall ignorance of the populace our education system and emphasis on history and economics appear to be tilted in the direction that highlight correlation and anecdotal evidence rather that fundamentals.  I understand it does not behoove me to openly ostracize a large segment of the population, but until we address core understanding of our economy and core principles of what makes our society tick then the partisan rifts will continue.

So let us tackle this "explanation" of inequality which is now being circulated on the internet and shared on Facebook with proud posters feeling rather enlightened about their "discovery".  Unfortunately the explanations are nothing more than illusory and are further fueling the partisan divide and the protests against the "haves" of the society.  The explanations either blame capitalism or Congressional policy favoring the rich.

Consider for example:  Plutocracy Reborn by Business Insider which attempts to convince the readers that it is our policy that is causing another Great Depression in America. Without digging deeper than the surface they present for most people what appears to be a very convincing argument as to why the current Congressional taxation policy has created our wealth gap.  

Another example: It's the inequality, stupid by Mother Jones showing a combination of pretty charts, graphs and bubbles that all attempt to convince the reader that the policies of America are entirely responsible for all the inequality in this country.

Too bad both sources are wrong.  They are showing the effect, without any explanation.

It is easy to scratch the surface, notice a correlation and run with it.  So stick with me for a little bit and I will show you the simple truth.  Yes, we have inequality, but this inequality is neither driven by the free market nor by tax policy.

I have taken the plutocracy picture and placed two graphs under it:

What you are looking at:

Top - Average income and the uncanny relationships between inequality and economic calamity.
Bottom left - Monetary base from 1918 to 1930 (amount of money controlled by the Federal Reserve)
Bottom right - Interest rates from 1954 to 2010.

I have also added green and red lines that clearly demonstrate the relationship between the amount of money in the system and income inequality.

Unfortunately we only have interest rate data going back to 1954, so the monetary base will have to suffice for the earlier years and while this comparison is not exact - the idea is the same, price of money.

If you treat money as a commodity, which it should be, then like any commodity there is a price.  We can measure the price of money by either looking at its value as it relates to other money (Euro vs Dollar) or its purchasing power or the rate of interest.  Interest rates are always a measure of how valuable money is at any given time.  If money is scarce then the interest rate is higher, if money is widely available then interest is lower.  Right?  Good.

As you can plainly see our centrally planned authorities dictate the price of the most vital and precious aspect of our economy, our money.  When these authorities incorrectly price our money we develop massive distortions.

Why does this happen?

Because money is priced through the banking system.  That is, the quantity of money increases (when rates are low) through the banking system first and then into the general economy later.  Therefore banks benefit first and foremost as they are the recipients of newly created money, while the rest of us poor shmucks see this increase in money through price increases.  If you think about it, provided production capacity remains the same then the price of all goods invariable increase *if* the supply of money goes up.  Yes?

So what does that look like?

Observe the massive price increase that began to occur around the 1970s.  There were two things that happened in the past 40 years that contributed to this jump.

1)  1971:  End of Bretton Woods and the US Dollar disconnecting from any material store of value (gold).
2)  1982:  A thirty year prolonged effort of systematically lower and lower rates, thus making money/credit cheaper and more plentiful.  As you can see in the first chart, we have now reached the floor at 0% interest rates or in more simpler terms the price of money is the lowest it has been in history.

Are there other effects of cheap money other than price increases?

Yes, salaries tend to go up.

Unfortunately the rate of salary increases does not keep up with the rate of price increases.  You can tell in fact that at the moment of the writing real income is now lower than it was before the recession of 2008, yet price increases are at their highest!

Why does that matter?  Because of the following:


Rise in prices affect the lower income families the most.   It is useful to look at the expenditure ratio of things like gas and food because these items are required for survival.

You need food and energy in order to produce and build capital.  Without capital there is no wealth.

Visually the picture is starting to coalesce.  The lower income families are having a harder and harder time building capital because they are spending at least half of their entire income on survival!   The bad news does not stop there unfortunately because the price of money causes yet another distortion.  It forces people to move potential capital into acquiring tangible goods instead of actually saving the money for more prudent purchases or investments.

This is the sad state of our society over the past 30 years:

As money becomes cheaper and more plentiful the rate of savings declined with it.  This was happening DESPITE the fact that prices for all items were going up.  Essentially this means that Americans were spending more and more, but getting less and less for it while diminishing their capital formation (wealth).  
You could argue for instance that purchasing items can be translated into wealth, but that is only true to a limited extent.  Most items that you buy depreciate and this is is precisely why gold was always used a store of value, it never depreciated.   Housing was another popular item for storing wealth, but houses also depreciate and the past few years demonstrated just how sharply prices can decline in what appears to be a traditional "store of value".
So what is the conclusion here?
In order for more and more Americans to participate in the American dream, there needs to be an accumulation of wealth.  Wealth is accumulated through capital formation or more simply put, saving money. Saving money is effective only when the savers are guaranteed that the money saved provides the same purchasing power before the saving, as it does after the saving.  In a climate where the amount of money is constantly expanded the saver gets no such guarantee.  Incidentally, people chasing stocks, houses and other risky mechanisms for capital formation are doing so precisely to mitigate the hardship of saving in the western world.
In order for money to be saved there must be excess income generated after the staples have been purchased.  As we saw up above, due to massive price increases due to money expansion the amount of disposable income is constantly getting reduced.   The days where a man could provide for his family and send kids through college are long gone,  price increase cause this and nothing else.
The last consequence of cheap monetary policy, credit.  Because money is cheap, debt is spurred.  Therefore people can much more easily accumulate debt because the interest paid on this debt is "negligible".  So not only are Americans not saving, but they are spending more and more on goods that they technically should be buying.  Whether that is electronics, cars or houses matters not.  As you can see, the appetite for consumption has steadily increased: 
Credit expansion causing housing bubbles is nothing new,  consider for example the Florida housing bubble of the 1920s.
Unfortunately when large portions of income are spent on survival items, savings are destroyed and debt obligations rise - you are left with nothing, hell, nothing would be preferable to the mountains of debt that people have accumulated. 
This is the source of our income inequality, this is what happens when the free market and capitalism are replaced with central planners and cronyism.  This is our America. 
Now what will you do to change it?