EC Two Pins Threatening Multiple Asset Bubbles

Inequality and Financial Stability: Two Pins Threatening Multiple Asset Bubbles

“Powell Says Fed Policies “Absolutely” Don’t Add To Inequality” -Bloomberg May 2020

The headline above is but one of countless times Fed Chairman Powell and his colleagues confidently said their policies do not result in wealth or income inequality. Their political stature and use of complex economic lingo give weight to their opinions in the media. Nevertheless, a deep examination of the Fed’s practices and their consequences leaves us to think otherwise.

In our opinion, the Fed’s contribution to wealth inequality is significant and grossly misunderstood. We have written articles explaining why QE and low-interest rates generally benefit the wealthy and harm the poor. This article backs up those prior arguments with quantitative muscle.

Timely for investors, we also draw some lines between wealth inequality and financial stability and their relationship to monetary policy. We think it is becoming increasingly possible wealth inequality, and in particular, the outsized effect inflation has on the poor, could be the needle to pop many asset bubbles. The other possible needle is the Fed’s wanting for financial stability.

**Due to the importance of monetary policy from economic, societal, and market perspectives we are breaking this article into two. We will share part two next week.

Background

More inflation and financial stability (rising asset prices) are two of the three core tenets backing the monetary policy. A strong labor market is the third objective. We focus on inflation in this article and financial stability in part II.

In our article Two Percent for the One Percent, we explain why inflation is detrimental to the poor while rising asset prices (financial stability) primarily benefit the wealthy. The following paragraphs from the article explain:

“With that in mind consider inflation from the standpoint of those living paycheck to paycheck. These citizens are often paid on a bi-weekly basis and spend all of their income throughout the following two weeks. In an inflationary state, one’s purchasing power or the amount of goods and services that can be purchased per dollar declines as time progresses. Said differently, the value of work already completed declines over time.While the erosion of purchasing power is imperceptible in a low inflation environment, it is real and reduces what little wealth this class of workers earned. Endured over years, it has adverse effects on household wealth.”

“Now let’s focus on the wealthy. A large portion of their earnings are saved and invested, not predominately used to pay rent or put food on the table. While the value of their wealth is also subject to inflation, they offset the negative effects of inflation and increase real wealth by investing in ways that take advantage of rising inflation. Further, the Fed’s historically low-interest-rate policy, which supports 2% inflation, allows the more efficient use of financial leverage to increase wealth.”

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Comments

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William K. 1 month ago Member's comment

The explanation provided about the damage of inflation to those not in the top ten percent is exactly what I have been asserting for a lot of year. And yet the apologists for those making it happen keep explaining how beneficial inflation is. Hopefully the change can be brought about by actions other than public executions of federal reserve bankers and policy makers, at least I hope so. BUT, given the damage already done, such might certainly be deserved.

Perhaps a more civil method would be to assure that no policy maker would be, or have been, a member of the upper 50% wealth class. Experience certainly can be a very powerful teacher.