The Rich Get Richer Thanks to the Fed

Bloomberg’s Matthew Klein has an article describing how Fed policies backed by the Obama administration continue to benefit the wealthy at the expense of everyone else. Walter Russell Mead writes, “This type of thing is an all-too common feature of blue politics. Despite the egalitarian and ‘social-justice’ impulses of the naive blue liberals at the grassroots, a decaying blue social model inevitably creates more inequality and privilege. Well-connected insiders get sweetheart deals from government, for example, and insurance lobbyists get to wield a veto power over Obamacare’s re-structuring of the American health care system. Most of the so-called green policies we’ve seen are basically ways to channel money from ordinary consumers to political insiders who invest in clever enterprises engineered to suck in subsidies or to thrive in protected, artificial markets created by regulations. Now Obama’s pick for Fed chief wants to add juice the economy by boosting the savings of the rich.”

Let’s put it in easy to understand terms. Say you have a checking/savings account with $10,000 in it. For argument’s sake we’ll imagine your bank pays you 1% on your money. This is pure imagination on my part because my bank pays a fraction of that. So after one year of leaving that money sit, you will have $10,100 in your account. Not great, but at least you got something for your money, right?

Wrong. According to this CPI calculator, you’ve lost money: Your $10,100 in 2013 is now worth only $9,903 in 2012 dollars. This is due to inflation which is officially running at 1.5% annually. This number is notorious for being easily manipulated by the government since it is a politicized statistic, and if it were calculated today the way it was by the government in 1990 the inflation rate would be closer to 5%.

Losing money is by design; it’s exactly what the Federal Reserve wants to happen to you and anyone else with money in the bank. When you earn a return less than inflation, economists say you are suffering the pain of “negative interest rates.” Klein writes, “Harming at least some savers, however, may be part of the plan, at least if Yellen agrees with Charles Evans, the president of the Federal Reserve Bank of Chicago. He has argued that the threat of wealth confiscation by negative interest rates is necessary to restore spending and “risk-taking” back to “normal levels.””

So wealth confiscation is necessary to force you to spend that $10,000 or risk it on the stock market. And some wonder why ordinarily sane people are attracted to Ron Paul’s “End the Fed” crusade.

In the grand scheme of things $10,000 isn’t a lot of money. It won’t get you a new car, or even a decent used one. It might get you a great vacation in the US for your wife and two kids, but abroad? Forget it. Airfare alone to Europe would eat up half that sum, and the while you can make do with the remaining $5k if you are smart with it, you won’t be living large by any stretch of the imagination during your vacation.

Of course if you spent it on a vacation, you’d have something to show for it: memories and snaps of you and the kids at the Arc de Triumph.  On second thought, screw France. You and the kids outside Buckingham Palace. But then you’ll come home and your car breaks down and needs a new engine, or your furnace breaks and you’re looking at a $2,000 bill for a new oil heater. Where do you get that money?

Instead of a vacation, you decide to invest it in the stock market. In case you haven’t heard, the stock market is at all-time highs. Over the past 14 years we have had two financial bubbles: one in the stock market and the other in real estate. Do you see anything similar between today’s stock market and those bubbles? Do you believe the market will go up long enough for you to make money on your investment if you buy at the top of the market?  There’s a South Park parody that shows what happens to small investors in this stock market: the money evaporates before their eyes.

Can you make money in this market? Of course, just like you can make money at roulette in Las Vegas. The only difference between investing in the stock market and betting it in Las Vegas is the speed at which you lose it. The end result is the same. There are ways to make money when the market collapses, but bear market investors and those who short the market have been burned over the past two years as the market has continued to defy rationality. As economist John Maynard Keynes once said, “the market can remain irrational longer than you can remain solvent,” and while the economic theory that bears his name sucks, the man at least knew a thing or two about markets.

Why is this happening? Why are the poor and middle class, those with more of their assets in bank accounts than the wealthy and particularly those on fixed incomes like seniors losing money? Because of the Federal Reserve’s policy of Quantitative Easing. QE makes money cheap by flooding the market with cash. In short what it is doing is buying debt from the federal government and then lending it to banks, thereby increasing the dollars in circulation. If the bank can borrow from the Fed for free, it doesn’t need to pay interest to savers. Additionally, increasing the supply of something makes that something worth less which is why many skeptics of the Federal Reserve are suspicious of official inflation statistics. The amount of dollars in the market should boost inflation, and it has; prices of products such as food and fuel are not included in the CPI, and everything from the smaller Dollar Menu at McDonald’s to the decreasing product sizes in the stores tell of inflation within the economy. Yet this “stealth inflation” goes unrecorded by official statistics.

Just as one might feel the pull of taking out that $10,000 and buying stock, the wealthy do too. The only real difference is that one’s $10,000 might represent 100% of one’s net worth whereas the wealthy have diverse portfolios that protect them regardless which way the market moves. That $10,000 might be your retirement nest egg. The wealthy don’t have a single egg, they have many and they have multiple baskets to put them in: stocks, bonds, offshore accounts, real estate.

But you have something with that $10,000 in the bank that they don’t: liquidity. You can go to the bank and within a minute or two leave it with $10,000 in hand. It’s hard to take that Soho apartment and turn it into cash instantly, so they borrow against it. From where? Banks of course. But wealthy people aren’t stupid; at least the ones who stay wealthy aren’t. They are sensitive to interest rates when they borrow money just like most people are. When interest rates are high, they’ll avoid taking. Low interest rates encourage them to take liens on their assets and turn it into cash – or rather chips for the Wall Street casino.

Providing them with cheap money to gamble encourages them to gamble more, and that’s exactly what the Fed wants.

The logic behind this is that by allowing the wealthy to get wealthier by gambling with cheap money society benefits because house prices rise and companies whose stock rises are more likely to invest in new jobs or equipment. Klein disagrees, writing, “The tens of millions of Americans who own neither shares nor their own homes may have benefited indirectly as relatively wealthy people got even wealthier, but that’s not much different than saying lower taxes on the rich improve the well-being of the poor. The increase in asset prices and collapse in real yields have also meant that workers have to save a larger chunk of their incomes to get the same quality of life in retirement.”

And speaking of retirement, a common argument used to justify policies that benefit Wall Street is that the common person benefits because their 401k is invested in the market. Therefore a rising stock market is good for everyone.  The problem with this argument is everyone doesn’t have a 401k. I don’t, and neither does 53% of the American population. 401k’s are also highly illiquid; it’s not easy to convert them to cash without incurring serious penalties, so most people only do so when they have life-changing events. These events tend to be random, as does how the market is performing during a window when a 401k holder is thinking about retiring. For working people a 401k statement during a bubble  is a psychological benefit. It makes them feel wealthy. But that profit is only worth as much as the paper it’s printed on until the person retires. Today those who are retiring and beginning to cash in their 401k’s are doing well. This wasn’t the case 5 years ago, and who is to say what things will be like in five years?

The Federal Reserve policies supported by this administration through it’s choice of Janet Yellin to head the Federal Reserve proves that both are redistributing wealth from relatively poor taxpayers to the wealthy. In a sense it is a tax on the poor whose proceeds are is then passed to the rich. Is this what President Obama’s supporters expected when they signed on for “hope and change?” This doesn’t even touch the moral issue of  the Federal Government running extraordinary deficits that will have to be borne by future generations in order to support today’s wealthy.

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  2. Geoffrey Britain:

    One more example of limited understanding and thus a partial and incomplete explanation.

    The Federal Reserve’s policy of Quantitative Easing is NOT motivated by a desire to make the rich richer at the expense of the poor and middle class. The rich are getting richer and the middle class poorer but that is a side effect, NOT the intent. The Federal Reserve’s policy of Quantitative Easing is motivated by a desire to keep the Ponzi scheme of fiat money going. If the Feds stopped qualitative easing, America would immediately slide into another great recession because every western nation is actually bankrupt, due to the long term inflationary effects of the west’s fiat money system. Fiat money is essentially characterized by a money system divorced from any physical, real world reference point. A fiat money system is by definition, disconnected from reality. Traditionally, that physical reference point has been gold but it is not gold itself that is important but that a money system be connected to reality, which is important.

    “QE makes money cheap by flooding the market with cash. In short what it is doing is buying debt from the federal government and then lending it to banks, thereby increasing the dollars in circulation.”

    Absolutely true but the reason why the politicians and Federal Reserve are using ‘QE” is to keep kicking the ‘economic can’ down the road. The SIDE effect of that ‘policy’ is to make the rich richer and the middle class poorer BUT…the alternative is a global crash that will make the 30’s ‘Great Depression’ pale by comparison.

    Disconnect a money supply from reality and you get to play all kinds of games with money, which allows those with financial resources to leverage it into huge gains. A consequential result of those games is the gradual draining of the middle classes assets of real value but that is NOT the intent of the rich, just “collateral damage”.

    But here is the dirty little secret of life; under capitalism or communism, over time, 80% of a society’s assets will gravitate into the hands of the ‘top’ 20%. Under capitalism it will be a combination of ‘old money’ and entrepreneurs. Capitalism allows for the merely lucky, the hard working and talented individuals to move from one socioeconomic class to another. Under communism it is the party elite and the ruthlessly ambitious. Under socialism, the natural gravitation of the bulk of assets into the hands of the few is artificially blocked BUT…because socialism is an artificial construct seeking to block a natural process, socialism inescapably blocks economic and technological progress and we end up with Churchill’s cogent observation; socialism’s inherent ‘virtue’ is, “the equal sharing of miseries”.

    Capitalism is not immoral, it is amoral. In nature, the lion does NOT ‘immorally’ kill an antelope. It AMORALLY kills the antelope. So too with economics, which takes no notice of the moral stature of those engaged in commerce. When a society ‘marries’ capitalism with the Judeo/Christian ethic of ‘brotherhood’ and natural individual rights, then a society’s engine of commerce is pulled by the balanced ‘horses’ of “the pursuit of the individual happiness” and societal ‘communion’.

    The result is stratospheric economic growth with a ‘rising tide that lifts all boats’. That does NOT mean that economic disparity ceases but that the ‘poor’ are demonstrably better in such a society, than in any other yet tried.

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  10. Scott Kirwin:

    Mr. Britain
    Excellent comment. Sorry for the delay in posting it. Although your interpretation of capitalism strikes me as a tad Marxist, that capital tends to accumulate in a capitalist society and therefore must be redistributed (or so says the socialist), you are correct about QE. The intent is NOT to make the rich richer, it is to avoid the consequences of prior actions creating and supporting a fiat currency. The result however is the same: the poor and middle class will get screwed no matter what. It’s just a question of timing.

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