While rising wealth-inequality gets lip-service from policy makers as a growing economic and societal problem, what is usually concealed is that it is the government’s very own policies that are primarily responsible for rising wealth-inequality. Ironically, some of these policies are supposed to benefit Americans, but those “benefits” are mostly going to the financial sector, the connected (and protected) class, and those already wealthy.
Inflation must surely be at the top of the list of negative economic forces masquerading as a positive. It speaks to the power of propaganda and obfuscation that inflation, paying more every year for the things we buy, is a good thing. As part of this campaign, for decades now, there has been fear-mongering from the Federal Reserve and other government officials that inflation is “too low”. Which is interesting, since when consumers pay less each year for computers or the newest technological gadget, they don’t seem to mind paying less. And yet somehow technology companies are still making healthy profits, and employing millions of workers. Perhaps not coincidentally, technology is one area that has relatively little government involvement. Compare this to areas heavily controlled by government like healthcare (more than half of healthcare dollars flowing through government), education (ditto), insurance (heavily regulated and protected) utilities (ditto), taxes and fees (to pay for it all).
A primary benefit of industrialization and specifically, technologic innovation, is that it drives down prices for consumers. And with increasing technology in nearly every industry, the efficiencies from improved technology should naturally drive overall prices lower, not higher. While there may be temporary rises in some prices due to unusual circumstances (such as shortages from natural disasters or resulting from temporarily higher energy prices), over the longer-term, improved technology and industrialization will naturally result in falling prices. Throughout most of modern history this has been the norm.
For example, according to data from the Minneapolis Federal Reserve, average consumer prices fell by half overall during the entire 19th century. That century included the massively inflationary War Between the States, yet still resulted in prices lower at the end of the century than at the beginning. This decline in cost of living helped lead to enormous gains in average standards of living over the century. This is what would be expected during normal economic expansion, as industrialization and technology improvements drive productivity gains and lower costs of living. (In a normal and competitive marketplace, the input prices of energy and most commodities, underlying nearly every consumer product, will almost always decline in real terms over the long-term.)
Conversely, when the Federal Reserve is free to print money at will, inflation and higher costs will be the norm, to the detriment of standard of livings. Data from the Minneapolis Fed shows that over just the last 50 years since 1967, consumer prices have increased more than seven times, averaging more than 4% increases per year. This period nearly perfectly coincides with the end of the gold standard in the U.S. and the end to the natural restraint of inflationary government policy.
While inflation harms the poor and middle class, it’s often a boon for the wealthy, who benefit from rising asset prices, particularly stocks. Inflation/money printing that is pushed through the system will cause overall inflation to rise, but assets such as stocks, real estate and commodities will often go up more quickly. This has certainly been the case over the last several years where stocks prices have doubled in five years, while inflation has said to have averaged barely 1% per year. (Many experts dispute the government’s official inflation statistics, and I suspect many or most individuals and families in America would as well). And since the poor and middle-class spend a much higher share of their income and assets one everyday spending than the rich, they will suffer the most from inflation.
The government, the Federal Reserve, knows very well how to cause higher prices, as it has often reminded us over the years. Money printing is not rocket-science (although there is continual tinkering with exactly which levers to push to reach the same goal). A higher supply of money will directly decrease the value of money already held by savers. Rising prices, inflation, will be the result. It’s actual government policy to create more inflation and avoid declining consumer prices. Falling prices are said to be bad, stable prices are “too low”, even a one percent yearly rise is “too low”. Two or three percent inflation (as reported) is “just right”.
Unfortunately, government-created inflation is harming the most financially vulnerable segment of the society. When living expenses rise more than salaries, pensions or Social Security payments (average Social Security cost-of-living increases of just 1.1% a year since 2010, and just 0.3% increase in 2017), they will see a declining standard of living. Despite a decade or more of being told there is very low inflation, medical expenses, which make up a very large and rising share of living expenses for tens of millions of Americans, particularly the aged and financially vulnerable, has been rising sharply. Below is a graph showing an index of health insurance (a proxy for medical expenses) in the U.S.
IN contrast, those already wealthy from stock market holdings, may welcome money-printing and rising inflation if it translates into sharply rising stock prices. Since their assets are much greater than their living expenses, the rise in stock gains will likely more than make up for rising cost of living expenses. Those who make their living from rising asset prices, the financial players, the bankers and hedge funds, along with the very wealthy, all do very well from sharply rising asset prices.
The government itself is often another major beneficiary of inflation. When stock prices rise faster than the overall level of economic growth, this will bring in artificially large tax revenues. And since governments have trillions of dollars of debts and increasing expenses (5% average yearly increase in federal expenditures over the last 15 years), they are very eager for any chance to boost their tax revenues. (By IRS design, capital gains do not exclude inflation from tax calculations, so higher inflation, particularly asset inflation, directly results in more government revenues, without the government having to “pay for it” with higher inflation costs.)
Low Interest Rates
The inflation that is engineered by the Fed comes mostly from low interest rates. In particular, keeping short-term interest rates less than 1%-2% above current inflation will tend to create more inflation, and keeping rates above that level will tend to put a break on inflation. And for nearly a decade now, U.S. interest rates have been far below this level, even using official inflation statistics. The graph below shows how historically, short-term interest rates were held a couple of percentage points above inflation. In the 1990s, interest rates were generally kept down close to the level of reported inflation. Since 2000, however, there has been a complete reversal of decades of economic history and policy, as interest rates have been pushed well below the level of stated inflation. And not just briefly, but nearly continually for 15 years.
While the Federal Reserve may want us to believe that having near-0% interest rates are beneficial for us, they are clearly not for lower and middle-income savers. In 2017 we are not even a full generation away from a time where Certificates of Deposits, CDs, provided a safe and substantial income stream for tens of millions of Americans. Not surprisingly, with such low overall interest rates, the rates that CD savers earn on their money is minimal. The graph below shows 6-month CD rates going back to the mid-1960s. We see that until recent times, it was rare that a saver could not get a safe 5% yearly return on his or her money, even for a short 6-month period.
CD savers of course received a sympathetic punishment from the Fed when they pushed interest rates below 1%, and then again (after a brief reprieve to counter the rising real estate bubble in the mid-2000s) when rates were driven to nearly 0% interest rates in 2009.
By the way, although the data in the graph above was discontinued by the St. Louis Fed in 2013, CD rates have stayed very low, consistent with overall low interest rates. The graph below shows 12-month CD rates (CDs under $100,000) for the last eight years. And the effect of those interest rates increases over the past year and a half, as part of the Fed’s plan to “normalize” interest rates? Those “bold” actions have increased the average 12-month CD rate from 0.20% per to year all the way up to 0.25% today.
With CDs and other safe investments bringing in less in interest income, many retirees are working longer to close the gap. The graph below shows labor participation rates in the U.S. Since 2000, the percentage of 25-54 year-olds in the workforce has declined by about three percentage points (from about 84% to 81%), the percentage of those over the age of 55 in the labor force has increased an amazing eight percentage points (from approximately 32% to about 40%). While there are many reasons why the percentage of older Americans are staying in the workforce longer (such as paying for high medical expenses and the high cost of living in general, as noted earlier), the meager earnings on savings isn’t helping matters.
Since, on average, the rich have many times greater stock holdings than the lower and middle-classes, they are not as dependent upon an income stream from CDs, bank savings (averaging less than 0.10% annually for several years), or similar safe investments. Their large pool of stock holdings can usually easily throw off enough income from dividends or capital gain distributions to supplement whatever expenses their income cannot. For the non-rich, the Federal Reserve has put millions of retirees in the position of accepting minimal income from safe investments or gambling in the stock market with hopes of avoiding a sharp market decline. These potential retirees are old to remember well the financial destruction to millions from the stock market declines of 2000 and 2008, and are justifiably apprehensive of going through the same thing again. Many will accept lower incomes or standard of livings and (for some) staying in the workforce longer than they’d prefer.
There’s a reason that safe and low-risk investments were created. A saver would earn a little less than risky investments, but would trade that risk for being able to sleep at night. Now however, savers in safe investments like savings accounts and CDs earn a lot less than riskier investments, and puts them in a very difficult conundrum. Take a large risk for a hopefully adequate return in the stock market, or take a low risk in safe investments, but a near-guarantee of earning insufficient and below-inflation returns.
Not sufficient savings
A correlary to the last point is that miniscule interest rates make it very difficult for the lower and middle-class to save. I’ve reprinted the graph from my last article showing the breakdown in median savings. The median net worth was only about 81,000 and that includes net equity in real estate.
Even among older savers, the situation isn’t a lot better. An analysis by the Government Accountability Office in 2015 found that nearly a third of American households over the age of 55 have no retirement savings or traditional pension plan. This group has a median net worth of only about $35,000 (primarily home equity) and just $1,000 in financial assets like stocks or bank savings. Approximately another quarter of American households had a defined-benefit plan but no other retirement savings.
And even for the half or so of older Americans with retirement savings, on average, they don’t have a lot. According to the survey, of those aged 55 to 64, the median amount of those who had retirement savings was about $109,000 and for those 65 to 74, $148,000.
Even in a world of normal or high interest rates, such savings amounts would not provide a large source of income in retirement, but these shortfalls are exaggerated when interest rates are so low. According to the GAO, given current interest rates, an annuity would provide just $310 a month for those with median savings in the age 55-64 age group and $649 a month for those with median assets at the 65-74 age group. Will $4,000 to $8,000 in extra yearly result in comfortable retirements? And remember, that’s for those who actually saved for retirement. Nearly a third of older Americans don’t even have that.
Altogether, among all households aged 55-64, it was estimated that 41% of pre-retiree American households have no retirement savings, and including them, a majority (55%) of the same age group had less than $25,000 in retirement savings.
In short, the average American, young or old, isn’t saving a lot for retirement, certainly not what will be required to finance an high standard of living in retirement, given today’s interest rates. Low interest rates have become a double-edged sword: not only do they discourage saving in favor of consumption during working years, they produce very low levels of income during retirement. (On a more macro level, negative real interest rates over-stimulate demand, further increasing inflation, cost-of-living and difficulty in saving.)
Unfortunately, every year that extremely low interest rates continue (now in the 9th year or so), consumers and savers become more conditioned to low interest rates. And as below-normal interest rates look more and more likely to hold for the indefinite future, savers respond accordingly. They save little, expect to work longer in retirement, adjust retirement standard of living expectations, or all of the above. And none of this looks like it will be changing any time soon.