Janet Yellen is the current chairman…um, chairwoman…er, chairperson of the Federal Reserve System. And Janet is “greatly concerned” about the rise in income inequality in the U.S.:
Federal Reserve Chair Janet Yellen said she’s “greatly” concerned by the most sustained rise in U.S. wealth and income inequality since the 19th century, while declining to offer any policy prescriptions.
The lower half of U.S. households by wealth held 1 percent of the total last year, according to 2013 data from the Fed Survey of Consumer Finances, while the wealthiest 5 percent held 63 percent, Yellen said today in the text of a speech prepared for delivery at a Boston Fed conference on economic inequality.
“The past few decades of widening inequality can be summed up as significant income and wealth gains for those at the very top and stagnant living standards for the majority,” Yellen said. “It is appropriate to ask whether this trend is compatible with values rooted in our nation’s history.”
And she should be, because the Fed causes income inequality through monetary policy:
James Rickards* in his book The Death of Money: The Coming Collapse of the International Monetary System explains how this has happened in America and will happen again. Rickards writes, “Critics from Richard Cantillon in the early eighteenth century to V.I. Lenin and John Maynard Keynes in the twentieth have been unanimous in their view that inflation is the stealth destroyer of savings, capital, and economic growth.”
Rickards warns, “Inflation often begins imperceptibly and gains a foothold before it is recognized. This lag in comprehension, important to central banks, is called money illusion, a phrase that refers to a perception that real wealth is being created, so that Keynesian ‘animal spirits’ are aroused. Only later is it discovered that bankers and astute investors captured the wealth, and everyday citizens are left with devalued savings, pensions and life insurance.” [Emphasis mine]
Rickards finds that the 1960s and 1970s are “a good case study in money illusion.” “Two lessons from the 1960s and 1970s are highly pertinent today. The first is that inflation can gain substantial momentum before the general public notices it… Second, once inflation perceptions shift, they are extremely difficult to reset,” states Rickards.
Is the Federal Reserve contributing to a money illusion?
According to Rickards, “[S]ince 2008 the Federal Reserve has printed over $3 trillion of new money, but without stoking much inflation in the United States. Still, the Fed has set an inflation target of at least 2.5 percent, possibly higher, and will not relent in printing money until that target is achieved.The Fed sees inflation as a way to dilute the real value of U.S. debt and avoid the specter of deflation. There in lies a major risk.” [Emphasis mine]
The classical definition of inflation is an increase in the money supply. This increase in the money supply results in each dollar in circulation losing purchasing power. And this loss of purchasing power is reflected by a rise in prices.
Inflation is good for people who (1) are in debt, (2) borrow money, and (3) have flexible incomes. If you are in debt or borrow money and the money supply is increased by the Fed, then each dollar that you borrowed is worth more than the dollars that you use to repay your creditor.**
If you have flexible incomes, like Bill Gates or Warren Buffett, then you also benefit from inflation. The wealth of Gates and Buffett is held not in dollars, but in stock in their companies. And stock prices are just like any other prices: when the value of the dollar is reduced by increasing the money supply, then the price of the stock increases as well. So inflation makes Gates and Buffett even richer! It’s like getting a Yahtzee!!!
** During the hyperinflation in Germany in 1923, some farmers were able to pay off the mortgages on their farms with a few eggs.
*** Damn, I’m good:
Janet L. Yellen, the chairwoman of the Federal Reserve, is regarded as a person of the highest integrity. And that is what’s so utterly confounding about the speech she gave in Boston last week about inequality. She did a wonderful job highlighting the growing disparity between rich and poor and how it is beginning to impinge upon what it means to be an American, but she ignored the fact that, in many ways, the Fed’s policies have compounded the problem.
Ms. Yellen’s speech seemed heartfelt. Yet, she has endorsed the Fed’s policies, started by her two immediate predecessors, Alan Greenspan and Ben S. Bernanke, that drove down interest rates to historically low levels – policies that have actually exacerbated the problem that she says she wants to correct.
She is failing to appreciate how Mr. Bernanke’s extraordinary quantitative easing program, started in the wake of the financial crisis, has only widened the gulf between the haves and have-nots. If she does understand, she certainly made no mention of it in her speech in Boston. Indeed, there was no mention whatsoever of the Fed’s easy monetary policies at all, let alone how they have helped to cause income inequality.
Quantitative easing adds to the problem of income inequality by making the rich richer and the poor poorer. By intentionally driving down interest rates to low levels, it allows people who can get access to cheap money on a regular basis to benefit in extraordinary ways.
The first beneficiaries are the big Wall Street banks, the so-called group of 22 primary dealers, which can borrow directly from the Fed, essentially free. Because banks are in the business of making money from money, they use the Fed’s money to make more money by trading with it, investing it in government debt and pocketing the profit or by lending it out at wide spreads. Thanks to the Fed’s low-interest rate policy, the big banks also make a lot of money by taking our deposits, which they also pay us virtually nothing for – my savings account pays me an annual interest rate of 10 basis points, or one-tenth of one percent — and lending them out at wide spreads. No other business on the face of the earth gets its raw material so cheaply. No wonder bank profits have soared.
Then there is the gift the Fed has given to Wall Street’s traders and investment bankers. The traders benefit because they know – and have known for years, thanks to the Fed’s telegraphing of its quantitative easing program – that the Fed will be a continuing buyer of their risky securities at (ever-rising) market prices. Since the onset of Mr. Bernanke and Ms. Yellen’s policy, the Fed’s balance sheet has grown to $4.5 trillion, from around $800 billion before the crisis. That’s a whole lot of securities bought at high, profitable prices and paid directly to Wall Street traders. The Fed might as well have been paying the traders’ seven-figure bonuses directly.
The Fed’s low-interest rate policies have also been a bonanza for Wall Street’s investment bankers – and their bonuses — as companies around the world race to raise debt capital at low rates. Wall Street, of course, takes a cut of every dollar of debt raised. The steadfastly low interest rates have also propelled the stock market to new highs. That, in turn, has also led to a bonanza of new equity being raised and more fees being paid to Wall Street.
Private equity firms also have benefited wildly from the low-interest rate environment. That allows them to borrow money cheaply and leverage the billions of dollars in equity – said to be $3.5 trillion these days — to buy and sell companies. The buyout firms, and of course Wall Street, also get fees from all this deal activity. The investors in private equity funds have benefited too, and this often includes state-employee and teacher pension funds. The endowment funds of colleges and universities have also benefited from the low-interest rate environment. But it is the fund managers, not the pensioners, who really rake in the money from this arrangement.
Let’s face it, until the Fed acknowledges the role it has played – and continues to play – in widening the gulf between rich and poor in this country, you’ll forgive me if I find speeches like the one Ms. Yellen gave in Boston last week to be more than just a little bit ironic.