Tuesday, September 17, 2013

A New Gilded Age

The period of the late 19th century, following the end of the civil war and before the arrival of WWI is now regarded as the Gilded Age, a period in American history where fortunes of previously unheard of levels were now being made by the likes of John Rockefeller in oil, Andrew Carnegie in steel and the railroad "robber barons" Vanderbilt and Stanford, as they became known.  The Gilded Age, its growing industry and unprecedented wealth soon attracted numerous European immigrants, with the greatest wave of these reaching American shores by the early 20th century.  Amidst all these riches, however, Wikipedia cites the Gilded Age to be one of equally, or perhaps unequally, great poverty in America with the average income of most families below $380 per year.

Social scientists and economists are now drawing parallels of the vast and growing income inequality of America today to that of the late 19th century.  Some have called it the second Gilded Age.  Without question income and wealth inequality is on the rise.  This fact was most recently pointed out in a number of articles that site the fact that just under 20% of the total income in America in 2012 went to the top 1%.  This is the highest share since 1928.  The top 10% earned a whopping 48% of total earnings last year. Perhaps more staggering, since the beginning of the economic recovery in 2009, 95% of income gains have gone to the top 1% of the population.  

At the same time, median household income has fallen for the fifth straight year for a cumulative loss of 8.7% (versus 2007).  Median family income is now the lowest, on an inflation adjusted basis, since 1995.   

Some have blamed Obama, some the culmination of prior administration policies.  Truth be known, Congress has very little direct control over income (other than by confiscating it through taxes) and the White House, even less.  Nonetheless, the evidence of inequality is irrefutable.  So if not administrative policy, what has changed over the past five years that might contribute to such growing income inequality? Monetary policy.

Since the onset of the Great Recession, the Fed has relied on two tools of monetary policy.  Short term interest rates, anchored by the Fed Funds Rate and Discount Rate, were dropped abruptly by the Fed in 2008.  Next Chairman Bernanke deployed a series of unconventional policy tools, known as QE or Quantitative Easing, the purchase of US Treasury and Mortgage Securities by the Federal Reserve.

Today, the Fed's balance sheet has swelled to $3.5 trillion of these securities, with new purchases added at the rate of $85 billion per month.  The recent talk of "tapering" is designed to gauge the level of reduction in the rate of monthly purchases, a phenomena the capital markets regard as tightening of policy.

Aside from the dubious benefits or market-related effects of QE, several things are clear as it regards our topic of income inequality.  First, the Fed's zero discount rate policy or ZIRP has simultaneously dropped the cost of funds of banks on deposits to zero (or near zero) while also lowering the rate of return to investors on bank deposits to this same rate. Economists have called this "greatest transfer of wealth from savers to the banking system in US history".  The banks have been substantially recapitalized through this process, at the expense of savers.  

Bank stocks have rallied, with the Fed shoveling cheap cash their way, which the banks have been all to eager to invest in the rising stock market.  It then should come as no surprise to anyone that the dominant US banking capital of New York has the worst inequality (or highest GINI coefficient) of any state in the country.  The top 1% of New Yokers earn 35% of total income.  The bottom 50%, just 9%.

Second, because the rate of interest on savings deposits, short term US treasury bonds and other fixed income securities, has been less than the rate of inflation, economists have referred to this negative real interest rate phenomenon as "financial repression".  Financial repression favors the issuers of debt, like the US government, and punishes investors in that debt who see their rate of interest turn negative when adjusted for inflation.

Lastly, QE was designed in part to lower mortgage rates in the economy, but also to promote a wealth effect by boosting the value of financial assets, principally stocks.  Given that stocks are disproportionately held by the wealthy, however, these capital gains have been disproportionately owned by the wealthy.  Now, also by surprise, we find growing income inequality among this very same group.

So let's recap what Fed policy has promoted over the past five years.  First, it has favored banks through low interest rates, at the expense of savers.  Second, it has favored the wealthy, as disproportionately large owners of stocks, from those of lesser means.  Lastly, it has punished retirees, young families, non-profit organizations and others seeking short term savings investments through low rates of return.  While we grouse about growing income inequality, the fact remains that the Fed today, more than that of the current or past administration is the party most directly responsible for this outcome.