Seeking Alpha
Small-cap, macro
Profile| Send Message| ()  

Yes, that is what some people are arguing. ZeroHedge, which must be the finest collection of curious economic ideas on the web, published an article with this theory, based on another one from Mark Spitznagel that appeared in the WSJ. It isn't so difficult to take the idea apart, so here we go.

The main theories behind their idea:

  • Inflationary policies amount to wealth distribution from the poor to the rich because the latter 'get' the new money first
  • Or at least because the rich have parked their wealth in assets that "tend to rise disproportionally due to the inflationary policy."
  • Middle class incomes started to stagnate and "curiously coincided with the abandonment of the gold exchange standard and the unfettered growth in money and credit that followed on its heels."

While inflation does have redistributional effects (from lenders to borrowers and from people on nominal income to those that are indexed), to seriously claim that inflation (and therefore the Fed) is responsible for rising inequality and the great stagnation of the US middle classes doesn't pass even the most elementary testing of the data. Let's give you the graph for US inflation first:

(click to enlarge)
You'll see that the 1970s is the period that had significant inflation, even running at double digits twice for a couple of months. But the actual development of inflation sits very uneasily with the increasing trend in inequality from the 1970s and especially with the stagnation in the median wage.

(click to enlarge)

(click to enlarge)

(click to enlarge)

There are numerous empirical observations that directly contradict the thesis that the Fed and inflation is directly responsible for rising inequality:

  1. Inequality should have risen fastest when inflation was accelerating in the 1970s. This simply didn't happen.
  2. Inequality should have been reduced when inflation collapsed in the early 1980s (as a result of..the Fed, so much for them being so inflationary) but this didn't happen either.
  3. Inflation and inequality should have risen in the 1930s when currencies were decoupled from gold, but this didn't happen either.
  4. In Argentina inflation has been (and is) rampant at 20%+ but inequality was actually significantly reduced, and this after the country came off the currency board with the US dollar which had greatly limited their abilities for monetary expansion.
  5. Other countries came of the Bretton Woods system at the same time, but the middle class income stagnation is largely a US phenomenon, which is curious, as the US didn't experience the highest inflation of these countries.
  6. Japan has embarked on bouts of QE, but despite that it suffers from deflation and inequality is low by international standards.

We're sure there is plenty of other empirical data that directly contradicts the thesis that the Fed and inflation are responsible for the rise in inequality.

However, ZeroHedge isn't the only one to relate rising inequality to the financial sector. James Galbraith has done the same, in a new book titled Inequality and Instability, he argues that it is related to the growth of the financial sector:

More specifically, as the financial world has exploded in size across the west, this has made bankers rich, and - equally importantly - pumped up the value of their assets, such as stocks and bonds. [FT]

While inflation data don't fit the rise in inequality, the growth of the financial sector undoubtedly is an important contributor. The reason for that is technological (electronic trading, etc.) and regulatory, that is, the drive to deregulate the financial sector that enabled it to grow and go wild.

This is by no means the only reason for rising inequality but it is an important one and it fits the facts much better than blaming inflation created by the Fed.

Now, the ZeroHedge article also argues that the Fed "gives money to their friends on Wall Street" (they get it "first," which is why inequality rises). Krugman has pointed out that this isn't a free lunch; he argued that:

  • While Krugman himself is clamoring for more expansionary monetary policy, the financial establishment most definitely isn't.
  • Insofar as it involves buying assets at the long maturity (QE), it compresses the yield curve which is bad for banks (which borrow short and lend long).
  • The Fed isn't "giving away" money, the banks have to give up assets.

While the litany of disparaging remarks these rather obvious observations seem to provoke is quite remarkable, it cannot hide the fact that these observations are simple truths. On the third point, here is a funny example (again from the ZeroHedge article):

Well, let's look at his voodoo economics claims (how on earth did this guy get a Nobel prize in economics? If ever you needed proof that the prize has become a contrary indicator, Krugman provides it in spades). First of all, you will notice that he fails to mention how exactly the Fed comes into a position to 'buy stuff'. It does that by printing money from thin air, which is actually the central point of Spitznagel's critique. Let's just ignore it!

No, Krugman didn't "ignore it," he merely pointed out that the banks have to give something up, real assets. It's not a free lunch for the banks.

Source: The Fed Isn't Responsible For Runaway Inequality